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BUSINESS  ACCOUNTING 

Harold  Dudley  Greeley,  C.P.A.,  Editor 


Volume  I — Theory  of  Accounts 

By  Harold  Dudley  Greeley 

II — Constructive  Accounting 
By  George  E.  Bennett 

III — Cost  Accounting 

By  DeWitt  Carl  Eggleston 

IV — Advanced  and  Analytical  Accounting 
By  Henry  C.  Cox 

V — Illustrative  Accounting  Problems 
By  Charles  F.  Rittenhouse  and 
Harold  Dudley   Greeley 


Business  Accounting 


VOLUME  I 

HEORY  OF  ACCOUNTS 


By 
HAROLD   DUDLEY  GREELEY,  LL.B. 

Certified  Public  Accountant;  Member  of  the  New  York  Bar; 
Member  of  National  Association  of  Cost  Accountants;  Mem- 
ber of  American  Institute  of  Accountants;  New  York  Manager 
of  the  Walton  School  of  Commerce;  Formerly,  Lecturer  on 
Accounting,  Columbia  University,  New  York 


Third  Printing 


NEW  YORK 

THE  RONALD  PRESS  COMPANY 
1921 

400G6 


Copyright,  1920,  by 
The  Ronald  Press  Company 


All  Rights  Reserved 


EDITORIAL  PREFACE 


Library 

HF 
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Gflb 
i/.l 


Ten  years  ago  almost  any  contribution  to  the  liter- 
ature    of    accountancy    would    have    been    welcomed. 
Today,  however,  with  the  increasing  number  of  excel- 
lent publications,  it  is  incumbent  upon  one  who  puts 
\      forth  a  new  accounting  work  to  justify  his  action. 
N       Much  more  is  it  necessary  to  explain  the  publication 
of  a  set  of  accounting  books.    Hence  it  is  desirable  to 
1  ^  state  at  the  outset  the  purpose  of  "Business  Account- 
-i  ing"  and  to  outline  its  scope  and  general  methods  of 

presentation. 
H         While  many  books  have  been  published  on  account- 
'^  ing  topics,  in  almost  every  case  they  are  unrelated  vol- 
^  umes.    In  some  few  instances,  a  volume  on  accounting 
'■0  has  logically  followed  another  by  the  same  author,  but 
with  these  few  exceptions  every  one  published  has  been 
2      written  without  connection  with,  or  adjustment  to,  any 
^     of  those  already  existing.    Under  these  conditions,  the 
student  of  accounting,  to  get  any  connected  and  logical 
knowledge  of  his  subject,  must  find  one  of  his  books 
here,  another  there,  a  third  somewhere  else,  and  bridge 
over  the  gaps  between  them  as  best  he  may.    The  proc- 
ess is  difficult,  and  the  accounting  knowledge  he  obtains 
is  not  always  well  co-ordinated  and  logically  developed. 
The  volumes  of  "Business  Accounting"  are  intended 
to  meet  this  situation.    They  cannot,  it  is  true,  provide 
a  course  of  study  in  the  sense  that  prescribed  readings 
are  recommended,  written  answers  to  questions  required, 
and  personal  instruction  given.     Neither  do  they  con- 

iii 


iv  EDITORIAL  PREFACE 

stitute  an  encyclopaedia  of  unconnected  and  isolated 
articles.  Rather  are  they  an  attempt  to  present  in 
simple,  non-technical  language  the  basic  principles  of 
account-keeping  and  their  application  to  various  lines 
of  business,  together  with  general  directions  for  prepar- 
ing, analyzing,  and  interpreting  accounting  statements. 

One  who  starts  at  the  beginning  of  Volume  I  and 
works  faithfully  through  to  the  end  of  Volume  IV,  and 
then  solves  the  problems  and  examines  the  solutions  of 
Volume  V,  should  acquire  some  real  understanding  of 
the  theory  and  practice  of  accounts — a  knowledge  that, 
supplemented  by  experience,  should  enable  him  success- 
fully to  stand  the  test  of  practical  work  in  any  ordinary 
business  office  and  furnish  a  foundation  for  going  as 
much  further  into  the  study  of  accountancy  as  he  may 
desire. 

It  may  be  noted  in  passing  that  the  volumes  of 
"Business  Accounting"  have  been  indexed  in  such  a 
way  as  to  provide  many  of  the  features  of  an  encyclo- 
paedia, so  that  the  person  desiring  the  practice  on  a 
particular  point  or  accounting  ideas  of  suggestive  value 
in  particular  lines  of  industry  will  be  able  to  use  the  set 
to  advantage. 

Taking  up  the  volumes  of  the  set  in  order — Volume 
I  presents  the  fundamental  principles  of  account-keep- 
ing and  statement  preparation.  Upon  these  basic  prin- 
ciples all  systems  of  account  are  built.  Volume  II  ex- 
plains the  principles  governing  the  development  of  the 
simple  accounting  procedures  described  in  Volume  I 
to  meet  the  needs  of  more  complicated  and  more  exten- 
sive systems  of  financial  accounting.  Volume  III  ex- 
plains in  much  the  same  way  how  the  basic  principles 


EDITORIAL  PREFACE  v 

have  been  applied  to  factory  or  cost  accounting.  Hav- 
ing thus  traced  the  fundamental  principles  into  more 
elaborate  financial  and  cost  accounting  procedures,  Vol- 
ume IV  treats  accounting  principles  and  practices 
which  are  more  advanced  than  the  basic  ones  described 
in  Volume  I.  These  advanced  principles  are  in  most 
cases  subject  to  differences  of  opinion,  as  to  their  nature 
or  application,  among  persons  qualified  to  deal  with 
them,  and  it  is  for  this  reason  that  their  discussion  is 
confined  to  Volume  IV.  Supplementing  the  illustra- 
tions of  accounting  principles  and  statement  prepara- 
tion, there  follows  in  Volume  IV  a  practical  discussion 
of  the  methods  of  verifying  accounts  and  statements  and 
of  their  interpretation  and  analysis. 

The  set  closes  with  Volume  V,  which  gives  a  num- 
ber of  problems  of  a  practical  nature,  together  with 
their  solutions.  The  working  of  these  problems  will 
not  only  clarify  the  reader's  ideas  but  in  many  cases 
will  provide  models  upon  which  he  can  base  accounting 
procedures  and  build  statements  to  meet  concrete  situa- 
tions arising  in  his  own  work. 

The  readers  to  whom  this  set  will  appeal  most 
strongly  may  be  divided  roughly  into  two  classes.  There 
will  be,  on  the  one  hand,  business  and  professional  men, 
bankers,  office  managers,  and  other  executives  who  feel 
the  need  of  understanding  in  a  general  way  the  methods 
of  modern  account-keeping  and  statement  preparation. 
There  can  hardly  be  excuse  nowadays  for  them  to  con- 
sider bookkeeping  methods  and  accounting  statements 
as  too  complicated  to  understand  or  of  such  slight  im- 
portance as  to  merit  no  attention.  They  need  a  grasp 
of  the  subject  so  that  they  may  judge  for  themselves 


vi  EDITORIAL  PREFACE 

whether  bookkeepers  and  other  persons  who  keep  ac- 
counts for  them  and  render  statements  to  them  are 
giving  information  which  is  accurate,  adequate,  and 
presented  in  the  most  intelligible  form.  The  entire 
tendency  of  modern  business  and  civic  life  is  toward 
more  exact  accounting,  of  which  the  accounting  re- 
quirements of  the  present  income  tax  legislation  are  but 
one  indication.  Any  person  having  substantial  inter- 
ests at  stake  should  be  able  to  appraise  intelligently 
the  stewardship  of  those  to  whom  his  interests  are  in- 
trusted and  the  volumes  of  "Business  Accounting"  will 
give  him  the  technical  information  this  demands. 

The  other  class  of  persons  to  whom  "Business  Ac- 
counting" will  appeal  is  composed  of  those  whose  duty 
it  is  to  keep  accounts  and  to  prepare  statements.  They 
should  find  in  this  set  an  inspiration  and  an  aid  to  more 
intensive  study,  which  in  turn  will  result  in  improved 
accounting  ability  and  an  enhanced  wage.  The  careful 
and  intelligent  use  of  these  books  will  lead  beyond  ques- 
tion to  increased  power  of  service  to  employer  and  com- 
munity. 

Harold  Dudley  Greeley, 

Editor,  Business  Accounting  Set. 

New  York  City, 
April  1,  1920 


PREFACE 

As  stated  in  the  editorial  preface  to  "Business  Ac- 
counting," the  underlying  purpose  of  this  first  volume 
is  to  explain,  in  readable  form,  the  fundamental  prin- 
ciples upon  which  all  account-keeping  and  statement 
preparation  are  based — to  give  a  clear  and  logical 
presentation  of  accounting  theory  and  practice  which, 
while  not  intended  to  go  into  the  refinement  required 
by  the  expert,  will  nevertheless  give  an  understanding 
of  the  technique  of  account-keeping  sufficient  for  all 
ordinary  business  purposes. 

The  present  volume  purposely  covers  the  field  of 
accounting  theory  in  a  broad  rather  than  an  intensive 
way.  It  suggests  many  problems  which  it  does  not  solve 
but  which  are  discussed  and  explained  in  succeeding 
volumes.  It  gives  simple  descriptions  of  all  the  funda- 
mental bookkeeping  and  accounting  procedures  and  ex- 
plains the  theory  underlying  the  usual  practices. 
Throughout  the  book  there  are  questions  and  practical 
examples,  including  a  few  sets  of  business  transactions, 
to  enable  the  reader  to  apply  the  theory  as  his  under- 
standing of  it  develops. 

As  this  book  covers  a  comparatively  unoccupied 
field,  namely,  that  lying  between  the  bookkeeping  of 
the  business  college  and  the  accounting  of  the  profes- 
sional school,  it  cannot  be  expected  that  the  method  of 
presentation  will  meet  with  universal  approval.     The 

vii 


viij  PREFACE 

author,  however,  particularly  desires  that  readers  will 
bear  in  mind  what  he  is  trying  to  accomplish,  and  give 
him  the  benefit  of  criticisms  and  suggestions  so  that  suc- 
ceeding editions  may  benefit  thereby. 

The  table  of  contents  indicates,  better  than  a  pref- 
ace could  explain,  the  scope  of  the  volume,  an  attempt 
to  explain  unquestioned  principles  and  methods  of  ac- 
counting procedure  in  a  non-technical  way  which  will 
be  of  value  to  the  readers  for  whom  it  is  intended. 


Harold  Dudley  Greeley 


New  York  City, 
April  1,  1920 


CONTENTS 


Part  I — Fundamental  Principles 
Chapter  Page 

I     Modern     Accountancy 3 

1.  The  New  Accountancy 

2.  The  Work  of  Accountancy 

3.  Recording  Financial  Transactions 

4.  Constructive  Accounting 

5.  Advanced  Accounting 

6.  Audits  and  Special  Investigations 

7.  Cost  Accounting 

8.  Accounting  Problems 

9.  The  Accountant's  Training 
10.  Public  Accountants 

II  Preliminary    Information 16 

1.  Essential  Terms 

2.  Definition  of  Sole  Proprietorship 

3.  Definition  of  Partnership 

4.  Definition  of  Corporation 

5.  Relation  Between   Proprietor  and  Business 

6.  Definition  of  Assets 

7.  Definition  of  Liabilities 

8.  Definition  of  Capital 

9.  Recording  Business  Information 

10.  Primary  Purposes  of  Bookkeeping  Records 

11.  Definition  and  Use  of  Statements 

III  Capital 28 

1.  Accounting  Definition  of  Capital 

2.  Economic  Definition  of  Capital 

3.  The  Accountant's  Viewpoint 

4.  Definition  of  Profit 

5.  Definition  of  Loss 

6.  Withdrawals 

7.  Definition  of  Deficit 

8.  Summary  of  Capital  Changes 

9.  Examples  of  Capita)  Changes 

IV  Double-Entry  Bookkeeping 38 

1.  Kinds  of  Bookkeeping 

2.  Analysis  of  a  Business  Transaction 

3.  Original    Entries    and    Their    Grouping    into 

Accounts 


x  CONTENTS 

Chapter  Page 

4.  The  Ledger 

5.  Illustrative  Transactions 

6.  The  Form  of  an  Account 
7y  The  Balance  of  an  Account 

V     Determination  of  Capital  or  Deficit      ...        46 

1.  Method  of  Ascertaining  Capital  or  Deficit 

2.  Statement  of  a  Going  Business 

3.  Recording  Subsequent  Facts  in  Accounts 

4.  Recording  Subsequent  Facts  Showing  Profit  or 

Loss 

5.  The  Use  of  Income  and  Expense  Accounts 

6.  The  Use  of  the  Profit  and  Loss  Account 


Part  II — The  Ledger 

VI     Classification  of  Ledger  Accounts     ....        57 

1.  Importance  of  Correct  Classification 

2.  Object  of  Classification 

3.  Real  and  Personal  Accounts 

4.  Nominal  Accounts 

5.  Extension  of  Classification  of  Accounts 

6.  Further  Subdivision  of  Groups  of  Accounts 

7.  Classification  as  an  Aid  to  Correct  Bookkeeping 

8.  Making  Offsetting  Entries 

9.  Classification  an  Aid  to  Preparation  of  State- 

ments 

10.  Asset  Accounts 

11.  Liability  Accounts 

12.  Capital  Accounts 

13.  Income  Accounts 

14.  Expense  Accounts 

VII     The  Trial    Balance 71 

1.  Introductory 

2.  Methods  of  Preparation 

3.  Avoiding  Needless  Repetitions 

4.  Uses  of  the  Trial  Balance 

5.  Limitations  of  the  Trial  Balance 
.    -                    (i.  Illustrative  Problem 

VIII     Determination  of  Profit  or  Loss 79 

1.  Double-Entry  Profit  and  Loss 

2.  Adjusting  Entries 

3.  Example  of  a  Mixed  Account 

4.  Ascertaining  the  Gross  Profit  on   Merchandise 

6.  Treatment  of  Other  Mixed  Accounts 


CONTENTS  xi 

Chapter  Page 

6.  Closing  Entries 

7.  Example  of  Closing  Entries 

8.  Proof  of  Correctness  of  Profit  and  Loss 

IX     Statement  of  Trading   and   Profit   and   Loss       89 

1.  Function  of  Statement  of  Profit  and  Loss 

2.  Trial  Balance  Before  Closing 

3.  Preparation  of  Closing  Entries 

4.  Incorrect  Statement 

5.  Title  of  Statement 

6.  Form  of  Statement 

7.  Deductions  from  Sales 

8.  Cost  of  Goods  Sold 

9.  Expenses 

10.  Prepayments 

11.  Capital  Income  and  Expense 

12.  Other  Income 

13.  Net  Income  Credited  to  Capital  Account 

14.  Closing  Drawing  Accounts 

15.  Corrected  Statement 

16.  Balance  Sheet 

X     Statement  of  Cash  Receipts  and  Payments     .      104 

1.  Use  of  Cash   Statements 

2.  Form  and  Content 

3.  Illustrative  Statement 

4.  Title  of  Statement 

5.  Dates  of  Statement 

6.  Details  on  Statement 

7.  Arrangement  of  Items 

8.  Accounts  Receivable 

9.  Cash  Sales 

10.  Interest  on  Bonds  Owned 

11.  Dividends  on  Stocks  Owned 

12.  Interest  on  Bank  Balance 

13.  Refunds  by  Creditors  for  Overpayments 

14.  Sale  of  Office  Desk 

15.  Alexander  Bishop — Additional  Capital 

16.  Accounts  Payable 

17.  Cash  Purchases 

18.  Show-Case 

19.  Wages  and  Other  Expenses 

20.  Alexander  Bishop — Drawings 

21.  Items  Not  Disclosed 

22.  Conclusion 

XI     The  Balance    Sheet 116 

1.  Definition  and  Purpose 

2.  Two  Forms  of  Arrangement 

3.  Arrangement  No.  1 


xii  CONTENTS 

Chapter  Page 

4.  Arrangement  No.  2 

5.  Deferred  Charges  to  Profit  and  Loss 

6.  Showing  of  Deficit 

7.  Showing  of  Liabilities 

8.  The  Nature  of  Capital 

9.  Contingent   Liabilities 

10.  Incorrect  Form  of  a  Balance  Sheet 

11.  Date  of  Balance  Sheet 

12.  Arrangement  of  Items 

13.  Inventory  Valuation 

14.  Working  Capital 

15.  Real  Estate  Mortgage 

16.  Facts  versus  Opinion 

17.  Corrected  Balance  Sheet 

18.  Balance  Sheet  and  Post-Closing  Trial  Balance 

XII     Statement    of    Affairs 129 

1.  Balance  Sheet  Information 

2.  Solvency  and  Insolvency 

3.  Inadequacy  of  Balance  Sheet  for   Insolvents 

4.  Statement  of  Affairs 

5.  Rules  for  Valuing  and  Stating  Assets 

6.  Rules  for  Stating  Liabilities 

7.  Example  of  a  Balance  Sheet 

8.  Information  Required  for  Statement  of  Affairs 

9.  Example  of  Statement  of  Affairs 

10.  Comments  on  Statement  of  Affairs 

11.  Deficiency  Account 

XIII     Realization  and  Liquidation  Statement     .     .     142 

1.  Duties  of  a  Liquidator 

2.  Statements  by  Liquidator 

3.  Form  of  Statement 

4.  Additional   Information  Required 

5.  Illustrative  Statement 

6.  Comments  on  Realization  and  Liquidation 

Statement 

7.  Assets  to  be  Realized 

8.  Liabilities  to  be  Liquidated 

9.  Assets  Realized 

10.  Supplementary  Credits 

11.  Liabilities  Liquidated 

12.  Supplementary  Debits 

13.  Liabilities  Unliquidated 

14.  Receiver's  Cash  Account  and  Balance  Sheet 

XIV     The  Use  of  Supporting  Schedules     ....     153 

1.  Interpretative  Presentation 

2.  Fundamental  Principle  of  Presentation 

3.  Method  of  Presentation 


Chapter 


CONTEXTS 


4.  Example  of  Exhibits,  Schedules,  and  Supporting 

Statements 

5.  Schedule  of  Notes  Receivable  or  Payable 

6.  Schedule  of  Accounts  Receivable 

7.  Schedule  of  Inventory 

8.  Schedule  of  Investments 

9.  Schedule  of  Capital  or  Surplus  Adjustments 

10.  Schedule  of  Sales 

11.  Schedule  of  Cost  of  Goods  Sold 

12.  Schedule  of  General  Expenses 

13.  Miscellaneous  Schedules 


Part  III — Simple  Journal  Records 


Page 


XV     The     Journal 


167 


1.  Insufficiency  of  Ledger  Record 

2.  Illustrative  Problem 

3.  The  Function  of  the  Journal 

4.  Form  of  the  Journal 

5.  Importance  of  Complete  Explanation 

6.  The  Use  of  "To"  and  "By" 

7.  Date  and  Amounts 

8.  Points  to  Observe  in  Posting 

9.  Rules  for  Journalizing 

10.  The  Development  of  the  Journal 

XVI      Illustrative  Problems  in  Journalization 

1.  Transactions  to   be  Journalized 

2.  Opening  the  Books  Illustrated 

3.  Transactions  in  Business 

4.  Purchases  and  Sales 

5.  Receipts  and  Payments 

6.  Returns   and  Allowances 

7.  Solution   of  Journal  Entries 


179 


XVII     The  Cash   Book 188 

1.  Segregation  of  Like  Transactions 

2.  Advantages  of  Subdivision  of  Journal 

3.  Development  of  Cash  Journal 

4.  Receipts  and  Payments  in  Separate  Books 

5.  Cash  Book  Form 

6.  Pettv  Cash 

7.  Dates 

8.  Footings 

9.  Banking  Cash  Receipts 

10.  Identification  of  Payment 

11.  Cash  Balance 

12.  Closing  the  Cash  Book 


xiv  CONTENTS 

Chapter  Page 

XVIII     Purchase    Records   • 198 

1.  Function  of  Purchase  Journal 

2.  Simple  Form  of  Purchase  Journal 

3.  Illustration  of  Use  of  Purchase  Journal 

4.  Purchases  Account 

5.  Perpetual  Inventory 

6.  Operation  of  Purchases  Account 

7.  Trading  Account 

8.  Estimating  the  Inventory 

XIX      Sales   Records 207 

1.  The  Function  of  the  Sales  Journal 

2.  Form  of  Sales  Journal 

3.  Sales  Account 

4.  Sales  to  Proprietor 

5.  Returned  Sales 

6.  Significance  of  Turnover 


Part  IV — Development  of  Journals 

XX     Mis-cELLANEors  Cash   Matters 215 

1.  Development  of  Modern  Cash  Book 

2.  Exchange 

3.  Exchanged  Checks 

4.  Interest  on  Deposits 

5.  Notes  and  Drafts  Collected 

6.  Deposits   Charged   Back 

7.  Notes  Paid  for  Depositor 

8.  Bank's  Charge  for  Carrying  Account 

9.  Void  Checks 

10.  Form  of  Bank  Statement 

11.  Reconciling    Cash    Book    Balance    with    Bank 

Balance 

12.  Method  of  Reconcilement 

13.  Bank  Columns  on  Cash  Book 

14.  Transfers  Between  Banks 

15.  Petty  Casli 

16.  Creation  of  the  Imprest  Fund 

XXI     Miscellaneous  Purchase  Matters 232 

1.  Simple  Form  of  Modern  Purchase  Journal 

2.  Fiscal  Periods 

3.  Terms 

4.  Analysis  Columns 

5.  Expense  Accounts 

6.  Folio  Columns 

7.  Monthly  Closing 


CONTENTS  xv 

Chapter  •  pAGE 

8.  Summary  Journal  Entries 

9.  Returned  Purchases 

10.  Development  of  Purchase  Journal 

XXII     The  Voucher  System 240 

1.  Inadequacy  of  Creditors  Ledger 

2.  The  Voucher  System 

3.  Vouchers 

4.  Operation  of  Voucher  Record 

5.  Posting  from  the  Voucher  Record 

6.  Proof  of  Controlling  Account  Balance 

7.  Unusual  Transactions 

8.  Voucher  Checks 

XXIII     Miscellaneous  Sales  Matters 249 

1.  Analytical  Form  of  Sales  Record 

2.  Monthly  Period;  Terms  and  Folios 

3.  Sales  Number 

4.  Charge  Sales 

5.  Cash  Sales 

6.  Sundry  Sales 

7.  Sales  to  Proprietor 

8.  Containers 

9.  Freight  Outward 

10.  C.  O.  D.  Sales 

11.  Returned  Sales 

12.  Special  Forms  and  Methods 


Part  V — Miscellaneous  Accounting  Topics 

XXIV     Controlling    Accounts 259 

1.  Introductory 

2.  Arrangement  of  Accounts 

3.  Advantages  of  Controlling  Accounts 

4.  Opening  of  Controlling  Accounts 

5.  Journal  Entry  to  Open  Controlling  Accounts 

6.  Devices  to  Save  Work 

7.  Current  Entries 

8.  Posting  to  Subsidiary  Ledgers 

9.  Accounts  Receivable  Ledger 

10.  Accounts  Payable  Ledger 

11.  Frequency  of  Posting;  Subsidiary  and  General 

Ledgers 

12.  LTnusual  Entries  in  Controlling  Accounts 

13.  Monthly  Trial  Balances 

14.  Controlling  Account  in  Subsidiary  Ledger 

15.  Extension  of  Controlling  Account  Principle 


xri 


CONTENTS 


Chapter 
XXV 


Page 

271 


Trade  Discount  and  Cash  Discount    .     .     . 

1.  Discounts  in  General 

2.  Trade  Discount 

3.  Method  of  Stating  Trade  Discount 

4.  Quick  Methods  of  Calculation 

5.  Factors  and  Reciprocals 

6.  Incidental  Use  of  Reciprocals 

7.  Trade  Discount  in  the  Accounts 

8.  Cash  Discounts 

9.  Basis  for  Calculating  Cash  Discount 

10.  Bonus  on  Total  Purchases 

11.  Bookkeeping  for  Cash  Discounts 

12.  Journalizing  Cash  Discount 

13.  Cash  Discounts  Recorded  as  Cash 

14.  Cash  Book  Column  for  Discount 

15.  Showing  of  Discount  on  Financial  Statements 

16.  Provision  for  Discounts  in  the  Closing  Entry 

17.  Desirability  of  Abolishing  Cash   Discounts 

XXVI     Illustrative  Cash  Book  Entries 284 

1.  Ruling  of  Cash  Book 

2.  Illustrative  Transactions 

3.  Cash  Book  Entries 

4.  Comment  on  Transactions 

5.  Postings  from  Cash  Book 


XXVII     Notes    and    Trade    Acceptances 


294 


1.  Definition  of  Promissory  Note 

2.  Notes  Receivable  and  Notes  Payable 

3.  Bills  of  Exchange 

4.  Dishonored  Notes 

6.  Bookkeeping  Upon  Receipt  of  Note 

6.  Bookkeeping  Upon  Collection  of  Notes 

7.  Bookkeeping  Upon  Dishonor  of  Note 

8.  Discounting   Notes   Receivable 

9.  Bookkeeping  at  Time  of  Discount 

10.  Bookkeeping  Upon  Payment  of  Discounted  Note 

11.  Bookkeeping  for  Dishonored  Discounted  Note 

12.  Note  Register 

13.  Bookkeeping  for  Notes  Payable 

14.  Trade   Acceptances 

15.  Bookkeeping  for  Trade  Acceptances 

XXVIII     Illustrative   Note   Transactions   Journalized     306 

1.  Use  of  Additional  Columns 

2.  Illustrative  Transactions 

3.  Illustrative  Form  of  Journal 

4.  Comment  on  Transactions 

5.  Monthly  Closing  Entries 


CONTENTS 


Chapter 

XXIX     Depreciation 


xvii 

Page 
815 


328 


1.  Definition  of  Depreciation 

2.  Causes  of  Depreciation 

3.  Kinds  of  Depreciation 

4.  Bookkeeping  for  Depreciation 

5.  Bookkeeping  for  Replacements 

6.  Determination  of  Depreciation  Rate 

7.  Straight-Line  Method 

8.  Fixed-Percentage-of-Diminishing- Value  Method 

9.  Sinking  Fund  Method 

10.  Appreciation  of  Land 

11.  Provision  for  Bad  Debts 

XXX     The  Use  of  Subsidiary  Books  Illustrated   . 

1.  Columnar  Subsidiary  Books 

2.  Transactions  to  be  Recorded 

3.  Illustrative  Forms 

4.  Comments  on  Entries  of  Transactions 

5.  Preparation  of  Statements 


XXXI     Partnership   Accounting — Opening   and   Cur- 
rent  Entries 338 

1.  Special  Features  of  Partnership  Accounting 

2.  Necessity  for  Separate  Capital  Accounts 

3.  Usual  Opening  Entry 

4.  Opening  Entry  When  Capital  Is  Indefinite 

5.  Opening  Entry  Where  No  Capital  Is  Contributed 

6.  Division  of  Profits  and  Losses 

7.  Bases  of  Division 

8.  Division  on  Basis  of  Capital  and  Time 

9.  Compensation  for  Unequal  Capital 

10.  Interest  on  Capital 

11.  Bookkeeping  for  Interest  on  Capital 

12.  Salaries  of   Partners 

XXXII      Partnership      Accounting — Dissolution      En- 
tries        352 

1.  Introductory 

2.  Methods  of  Dissolution 

3.  Causes  for  Dissolution 

4.  Procedure  Upon   Dissolution 

5.  Bookkeeping  Upon  Dissolution 

6.  Illustrative  Problem 

7.  Liquidating  Dividends 

8.  Avoiding  Overpayment  of  Partners 

9.  Debit  Balance  Against  Partner 
10.  Sale  of  Partnership  Business 


xviil 


CONTENTS 


Chapter 
XXXIII 


4 


Corporation  Accounting 


Page 
362 


1.  Nature  of  Corporation 

2.  Peculiarities  of  Corporation  Accounting 

3.  Legal  Requirements 

4.  Capital  Stock 

5.  Kinds  of  Capital  Stock 

6.  Simple  Opening  Entry 

7.  Bookkeeping  for  Capital  Stock  Issued 

8.  Opening  Entry  Involving  Good-will 

9.  Treasury  Stock 

Part  VI — Single-Entry  Bookkeeping 

XXXIV     Principles  of  Single-Entry  Bookkeeping  . 

1.  Fundamental    Characteristic    of    Single-Entry 

Bookkeeping 

2.  The  Day-Book 

3.  Requirements  for  the  Day-Book 

4.  Inclusiveness  of  the  Day-Book 

5.  Necessity  and  Methods  of  Posting  to  Ledger 

6.  The  Ledger 

7.  The  Cash  Book 


377 


XXXV     Single-Entry  Statements 385 

1.  Insufficiency  of  Single-Entry  Ledger  Accounts 

2.  Statement  of  Condition 

3.  The  Form  of  the  Statement 

4.  The  Simplest  Form  of  Statement 

5.  Comparative  Statement  of  Condition 

6.  Inadequacy  of  Comparative  Statement 

7.  Method  of  Determining  Profit  or  Loss 

8.  Formulas  for  Determining  Profit  or  Loss 

9.  The  Asset  and  Liability  Method 

10.  Tangible  and  Intangible  Assets 

11.  Inadequacy  of  Single-Entry  Method 


XXXVI 


Part  VII — Account  Classification 

Analysis  of  Debit  Accounts  .... 


1.  Rules  for  Journalizing 

2.  The  Trial  Balance 

3.  Detailed  Analyses 

XXXVII     Analysis  of  Credit  Accounts 

1.  Introductory 

2.  Detailed  Analyses 


899 


415 


FORMS 


Form  Page 

1.  Ledger  Accounts  with  Postings       43 

2.  Cash    Book — Simple   Form 191 

3.  Purchase     Book        200 

4.  Sales  Book 208 

5.  Cash  Book,  showing  Net  Receipts  and  Payments    ....     216,  217 

6.  Monthly   Bank  Statement 224 

7.  Purchase  Journal,  showing  Purchases  by  Departments    .     .     234,  235 

8.  Voucher    Folder 242 

9.  Voucher    Record 244,  245 

10.  Sales  Journals,  showing  Sales  by  Departments 250,  251 

11.  Cash   Book,   showing   Ledger   Controlling   Entries   and   Discount 

Columns 288,  289 

12.  Columnar  Journal,  showing  Note  Transactions 309 

13.  Cash  Book,  showing  Ledger  Controlling  Entries     ....     330,  331 

14.  General  Journal 332 

15.  Sales    Book        332 

16.  Purchase    Book       333 

17.  Day-Book 379 

18.  Ledger  Accounts,  showing  Postings  from  Day-Book 382 

19.  Cash   Book   under  Single-Entry   Bookkeeping 383 


xlx 


Theory  of  Accounts 

Part  I 
Fundamental  Principles 


CHAPTER    I 
MODERN  ACCOUNTANCY 

1.    The  New  Accountancy 

One  of  the  most  striking  developments  of  business 
organization  today  is  the  way  in  which  methods  of 
record  and  control  have  kept  pace  with,  and  in  fact 
made  possible,  the  steady  increase  in  size,  volume,  and 
complexity  of  business  operations.  This  has  been  due 
to  the  modernization  of  accounting  methods  by  which 
all  business  transactions  are  fully  and  accurately  re- 
corded and  their  results  interpreted.  Accordingly  as 
business  increases  in  volume  and  complexity,  new  and 
more  difficult  problems  of  finance  and  management 
arise,  accounting  takes  a  higher  and  more  important 
position,  and  the  need  for  a  better  knowledge  of  the 
subject  on  the  part  of  business  men  as  well  as  account- 
ants is  more  clearly  and  more  generally  recognized. 

Owners  and  executives  now  look  to  accounting 
records  to  give  them  prompt  and  accurate  information 
and  guidance  on  matters  which  a  few  decades  ago  were 
left  to  conjecture,  but  which  today  are  closely  watched 
and  controlled.  As  a  result  of  this  the  demands  made 
upon  the  art  and  skill  of  the  accountant  in  reducing 
masses  of  data  to  orderly  systems  of  record  and  control 
are  steadily  increasing,  and  there  has  come  about  a 
remarkable  development  of  accounting  methods  and 
practice. 

The  old  accounting  was  good  as  far  as  it  went  and 

3 


4  FUNDAMENTAL  PRINCIPLES 

has  become  incorporated  in  the  new.  The  final  goal  of 
all  accounting — the  profit  and  loss  account  and  the 
balance  sheet  —  is  substantially  the  same  as  it  al- 
ways was;  but  the  fact  is  generally  recognized  that 
the  simpler  accounting  methods  of  early  days  are  quite 
inadequate  under  present-day  conditions.  Modern 
accounting,  as  intimated,  does  much  more  than  merely 
record  financial  facts  for  the  purpose  of  showing  final 
results  on  the  balance  sheet.  It  aims  to  insure  a  com- 
plete and  accurate  report  of  business  activities  day  by 
day,  to  detect  error,  to  make  fraud  difficult,  to  save 
labor — clerical  and  other — to  trace  wastes  and  compare 
efficiencies,  and  to  summarize  results  in  such  a  way  that 
the  most  profitable  course  in  the  future  is  as  clearly 
indicated  as  are  the  errors  which  have  caused  losses  in 
the  past.  Modern  accounting  methods  have  thus  be- 
come, to  an  extent  not  realized  by  those  who  have  not 
followed  their  recent  developments,  an  essential  part 
of  the  mechanism  of  every  highly  organized  and 
efficient  business  enterprise.  The  financial  worth  of 
a  business  may  be  clearly  read  from  its  balance  sheet 
and  profit  and  loss  statements.  Comparative  state- 
ments and  supporting  schedules  will  show  as  clearly 
where  it  has  been  gaining  or  losing  and  its  general 
trend.  To  the  accountant  or  to  the  business  man  with 
some  knowledge  of  accounting,  such  facts  are  easily 
gained  from  the  accounting  records  and  are  invaluable  as 
a  basis  for  judgment  and  action.  To  the  many  business 
men,  however,  who  know  little  or  nothing  of  account- 
ing, these  same  records  are  almost  meaningless  and 
their  facts  are  inaccessible.  A  large  percentage  of 
business    failures    is    directlv    due    to   the    absence    of 


MODERN  ACCOUNTANCY  5 

proper  accounting  or  the  inability  to  read  and  under- 
stand clearly  its  records. 

2.    The  Work  of  Accountancy 

Accountancy  has  been  defined  as  the  profession 
which  has  to  do  with  the  recording,  presenting,  and  veri- 
fying of  facts  concerning  the  acquisition,  production, 
conservation,  and  transfer  of  values.  This  definition, 
like  other  exact  definitions,  would  need  considerable 
elaboration  to  give  a  full  and  clear  understanding  of 
the  aims  and  methods  of  modern  accountancy.  It 
furnishes,  however,  a  logical  and  convenient  classifica- 
tion of  the  work  of  accountancy  into  three  main 
functions : 

1.  Recording    the    financial    transactions    of    a 

business. 

2.  Summarizing  the  results  and  thus  showing  the 

effect  of  these  transactions  upon  the  business. 

3.  Verifying  the  accuracy  of  the  values  shown  on 

the  books  and  records. 

The  first  two  volumes  of  the  present  set,  i.  e., 
"The  Theory  of  Accounts,"  and  "Constructive  Account- 
ing," discuss  the  recording  of  the  financial  transactions 
of  a  business  in  its  various  phases,  and  also  consider  the 
second  function,  statement-making,  in  a  preliminary 
way. 

The  third  volume,  "Cost  Accounting,"  deals  with 
that  special  phase  of  accounting  which  concerns  the  cost 
of  production. 

The  fourth  volume,  "Advanced  and  Analytical  Ac- 
counting," presents  some  of  the  more  difficult  phases 


6  FUNDAMENTAL  PRINCIPLES 

involved  in  recording  financial  transactions  and  dis- 
cusses statement-making  and  certain  phases  of  auditing. 
The  fifth  volume,  "Illustrative  Accounting  Prob- 
lems," consists  of  problems  illustrating  the  entire  sub- 
ject matter  of  the  preceding  volumes. 

3.    Recording  Financial  Transactions 

In  recording  financial  transactions  the  first  respon- 
sibility of  the  accountant  is  to  see  that  the  current  trans- 
actions of  the  business  are  accurately  entered,  properly 
classified,  and  so  grouped  that  the  total  sales,  purchases, 
and  other  significant  figures  for  any  period  can  be  ascer- 
tained at  any  time.  This  is  the  work  of  the  routine  book- 
keeper, but  the  ability  to  perform  or  direct  this  work  for 
a  business  house  demands  a  thorough  understanding  of 
accounting  principles,  their  theory  and  practice.  These 
are  presented  in,  and  form  the  subject  matter  of,  the 
present  volume. 

All  the  ordinary  and  usual  business  happenings  can 
be  properly  recorded  by  any  intelligent  bookkeeper 
without  the  aid  of  a  professional  accountant,  if  the 
system  of  accounts  which  the  bookkeeper  is  using  is 
adequate.  Unusual  and  peculiar  financial  transactions, 
however,  are  sometimes  very  difficult  to  record  so  that 
their  exact  nature  will  be  apparent.  It  is  necessary  so  to 
set  them  down  that  the  rights  of  all  parties  con- 
cerned may  be  accurately  determined  from  the  evidence 
of  the  entries,  and  it  is  here  that  the  routine  bookkeeper 
sometimes  fails.  When  he  does,  the  accountant  is  later 
called  upon  to  adjust  or  correct  the  incomplete  or  erro- 
neous entries — something  that  is  often  difficult  and 
sometimes  impossible. 


MODERN  ACCOUNTANCY  7 

The  accountant  is  vitally  interested  in  the  correct- 
ness of  the  bookkeeping  procedure,  as  upon  this  largely 
depend  the  safe  conduct  of  the  business  and  the  ease 
and  accuracy  with  which  the  final  results  can  be  sum- 
marized and  verified. 

4.    Constructive  Accounting 

The  accountant  must  not  only  be  conversant  with 
the  form  and  design  of  the  bookkeeping  records  com- 
monly used,  but  he  must  be  capable  of  devising  and  in- 
stalling systems  of  accounting  adapted  to  record  the 
transactions  of  any  particular  business.  This  is  termed 
constructive  accounting. 

In  the  design  and  installation  of  these  various 
systems  the  work  of  the  accountant  has  been  likened  to 
that  of  an  architect.  The  analogy  holds  in  that  before 
the  accountant  can  go  to  work  he  must,  like  the  archi- 
tect, ascertain  the  needs  of  his  client  and  the  purpose 
to  be  served  by  the  system  (or  building)  before  the 
plans  can  be  drawn.  A  stock  or  standard  accounting 
system  guaranteed  to  work  smoothly  in  every  business 
of  a  certain  kind  or  class  is  no  more  feasible  and  practi- 
cable than  would  be  a  standard  or  stock  building  plan 
guaranteed  to  meet  the  needs  of  all  requiring  office 
buildings  or  factories,  or  dwelling  houses.  There  are, 
however,  certain  principles  of  construction,  roughly 
analogous  to  the  principjes  applied  by  the  architect,  as 
well  as  certain  practical  expedients  in  the  way  of  books, 
rulings  of  forms,  office  short-cuts,  and  the  like,  with 
which  the  accountant  must  be  familiar.  When  he  has 
acquired  a  knowledge  of  these  he  can  intelligently  plan 
a  system  which  will  be  free  from  needless  complexities 


8  FUNDAMENTAL  PRINCIPLES 

or  formalities,  and  at  the  same  time  give  the  information 
required  in  any  given  case  with  a  minimum  expenditure 
of  time  and  effort. 

Constructive  accounting  with  the  fundamental 
forms,  records,  and  procedure  upon  which  all  special 
systems  are  more  or  less  based  is  treated  in  Volume  II 
of  "Business  Accounting." 

5.    Advanced  Accounting 

The  second  general  division  of  the  accountant's 
work  is  the  presentation  of  the  facts  concerning  finan- 
cial transactions  during  a  certain  period  in  the  form  of 
clear  and  logical  statements.  An  accountant  who  has 
merely  ascertained  and  recorded  the  facts  of  the  case 
before  him  has  no  more  finished  his  work  than  has  a 
lawyer  who  has  merely  ascertained  and  recorded  the  facts 
in  a  case  in  which  he  in  engaged.  The  accountant  has  still 
to  present  his  facts  in  a  way  to  make  the  financial  his- 
tory of  the  business  intelligible  to  his  client,  just  as  the 
lawyer  must  present  his  facts  in  such  a  way  as  to  con- 
vince a  jury  or  the  court.  As  a  means  to  this  end  the 
facts  shown  by  financial  statements  are,  when  necessary, 
fortified  by  exhibits  or  schedules  of  supporting  figures, 
the  whole  being  usually  supplemented  by  comments  in 
narrative  form. 

The  arrangement  of  the  figures  in  the  exhibits  and 
schedules  so  that  they  will  not  be  misleading  is  an  art 
which  is  not  easy  to  acquire.  Figures  may  be  true  but 
at  the  same  time  misleading.  For  example,  the  average 
net  profits  of  a  business  for  a  given  period  of  years  may 
be  truthfully  shown,  but  if  the  net  profits  have  been 
decreasing  steadily  during  the  period  covered,  and  this 


MODERN  ACCOUNTANCY  9 

vital  fact  is  not  stated,  an  estimate  of  future  profits 
based  upon  the  given  average  would  be  misleading.  A 
careful  accountant  would  not  report  the  average  in  such 
a  case  without  a  qualifying  statement  or  explanation 
calling  attention  to  the  continued  decrease  so  that  no 
one  could  be  misled  into  considering  the  average  as  in- 
dicating the  present  earning  power  of  the  business. 

The  accountant's  report  or  statement  is  sometimes 
used  for  publicity  purposes  and  in  this  case  he  must 
make  his  report  so  clear  that  it  may  be  understood  by 
anyone,  even  though  unfamiliar  with  accounting. 

In  Part  IV  of  Volume  IV,  "Advanced  and  Ana- 
lytical Accounting,"  the  subject  of  preparing  statements 
and  reports  is  taken  up. 

Both  in  recording  the  financial  transactions  of  a 
business  and  in  preparing  its  statements  and  reports, 
certain  matters  of  unusual  complexity  or  difficulty — 
real  or  apparent — are  encountered.  Reserves  must  be 
established;  amortizations  must  be  made;  consolidated 
balance  sheets  and  statements  may  be  required.  The 
more  difficult  phases  of  accounting  procedure  such  as 
these  are  also  treated  in  Volume  IV. 

6.    Audits  and   Special   Investigations 

The  final  division  of  the  accountant's  work  is  the 
verification  of  the  results  of  financial  transactions  as 
shown  by  the  statements  submitted  and  the  supporting 
records.     This  includes: 

1.  Auditing,  which  may  be  defined  as  the  examin- 
ation of  the  books  and  records  of  a  business 
so  that  any  inaccuracies  may  be  discovered 
and  its  condition  may  be  exactlv  determined. 


10  FUNDAMENTAL  PRINCIPLES 

2.  Special  investigations,  which  are  not  complete 
audits,  but  are  examinations  undertaken  to 
discover  or  demonstrate  particular  facts  or 
conditions. 

The  point  of  view  of  the  auditor  is  that  of  an  im- 
partial scientific  investigator.  In  digging  out  the  facts 
as  to  the  result  of  business  transactions,  it  is  necessary 
to  do  much  more  than  test  the  arithmetical  accuracy  of 
the  books  and  other  records.  The  books  are  intended 
to  record  the  financial  history  of  the  business  and  the 
investigator  must  not  only  ascertain  whether  or  not  the 
record  is  accurate,  but  in  addition  whether  it  so  states 
the  facts  that  it  is  clear,  impartial,  and  true. 

The  auditor  must  learn  the  history  of  the  business 
under  examination  from  the  accounting  records  or  by 
any  other  means  available  to  him.  The  books  of  account 
when  written  by  bookkeepers  who  lack  the  historical 
point  of  view  or  the  technical  accounting  ability  to  ex- 
press facts  completely  and  unequivocally,  do  not  always 
properly  record  the  history  of  the  business.  Just  as 
a  person  untrained  in  the  art  of  writing  would  fail  to 
write  a  reliable  history,  so  a  bookkeeper,  untrained  in 
recording  completely  and  correctly  all  financial  facts, 
would  fail  to  prepare  a  record  of  financial  transactions 
which  would  be  complete  and  historically  accurate.  The 
auditor  must  be  able  to  verify  and  supplement  the  book- 
keeping records  so  as  to  discover  the  facts  in  their  com- 
pleteness. 

Methods  of  verification  and  of  correct  interpreta- 
tion of  the  financial  facts  as  exhibited  by  statements  or 
recorded  on  the  books  are  considered  in  Volume  IV, 
"Advanced  and  Analytical  Accounting." 


MODERN  ACCOUNTANCY  11 

7.  Cost  Accounting 

Volume  III  of  "Business  Accounting"  discusses  the 
subject  of  cost  accounting,  which  involves  a  specialized 
application  of  the  principles  and  methods  developed  in 
the  preceding  volumes.  It  covers  both  the  operation 
and  the  interpretation  of  systems  of  cost  records  for 
manufacturing  businesses,  where  it  is  desirable  to  know 
the  cost  of  making  each  article  or  class  of  article. 

Cost  accounting  is  a  comparatively  new  develop- 
ment, but  its  importance  as  the  chart  and  compass  of 
sound  and  alert  factory  management  is  being  increas- 
ingly recognized.  So  far  it  has  been  developed  chiefly 
in  connection  with  manufacturing  concerns,  either  as  a 
means  of  detecting  wastes  and  inefficiencies  and  raising 
standards  of  performance,  or  because  the  factory  is 
obliged  to  sell  its  products  in  a  highly  competitive 
market  and  must  therefore  know  its  costs  in  order  to 
continue  to  do  business.  It  is,  however,  just  as  im- 
portant to  determine  the  cost  of  operating  or  selling  as 
the  cost  of  production,  and  this  volume  treats  the  sub- 
ject as  fully  as  its  growing  importance  demands.  The 
successful  business  man  of  today,  whatever  his  line  of 
activity,  must  give  the  closest  attention  to  the  cost  of 
doing  business  to  find  out  exactly  how  much  profit  he  is 
making,  or  what  loss  he  has  incurred  on  every  article 
made  or  sold,  on  each  piece  of  work  undertaken,  and 
on  each  of  the  departments  into  which  his  business  is 
divided. 

8.  Accounting  Problems 

Practice  in  the  application  of  theory  is  as  necessary 
to  the  mastery  of  accounting  as  it  is  to  the  mastery  of 


12  FUNDAMENTAL  PRINCIPLES 

any  other  technical  subject.  To  provide  this  essential 
practice  which  alone  leads  to  proficiency  in  the  prin- 
ciples and  theories  explained  in  the  first  four  volumes, 
Volume  V  is  wholly  devoted  to  a  series  of  accounting 
problems.  These  are  intended  to  cover  the  principles 
of  accounting  given  in  the  four  preceding  volumes  and 
have  been  selected  to  fit  in  with  and  illustrate  their  text. 
The  student  of  accountancy  who  masters  the  informa- 
tion of  the  preceding  volumes  and  works  out  the  appli- 
cation of  this  same  information  in  Volume  V,  should 
acquire  that  fundamental  grasp  of  the  theory  and  prac- 
tice of  accounting  which  distinguishes  the  accountant 
from  the  routine  bookkeeper.  Among  the  problems 
presented  are  many  which  have  been  given  in  the 
C.  P.  A.  examinations  of  the  various  states.  Some  of 
these  are  to  be  found  in  existing  volumes  of  accounting 
problems.  Many  of  the  problems,  however,  are  not 
found  elsewhere,  either  having  been  given  in  accounting 
examinations  subsequent  to  the  date  of  publication  of 
the  other  volumes  referred  to,  or  having  been  con- 
structed specially  for  the  purposes  of  these  books. 

9.    The  Accountant's  Training 

The  accountant  who  wishes  to  rise  to  the  higher 
ranks  should  come  to  the  study  of  his  profession  with 
a  fairly  liberal  education,  and  in  addition,  some  con- 
siderable knowledge  of  the  principles  and  practices  of 
modern  business.  He  should  have  a  complete  knowl- 
edge of  such  parts  of  the  law  of  his  state  and  the  country 
at  large  as  relate  to  business  transactions.  He  should 
also  have  a  fair  understanding  of  the  general  principles 
of  economics.    Beyond  this,  he  must,  of  course,  have  a 


MODERN  ACCOUNTANCY  18 

very  thorough  knowledge  of  the  principles  of  bookkeep- 
ing and  accounting,  which  must  sooner  or  later  be  sup- 
plemented by  actual  commercial  practice. 

The  accountant  may  be  conceived  as  standing  at  the 
apex  of  a  pyramid  whose  base  is  economics.  Economics 
covers  the  fundamental  principles  which  control  the 
general  relations  of  man  to  man,  such,  for  example,  as 
the  so-called  law  of  demand  and  supply.  Based  upon 
economics  and  somewhat  narrower  in  its  scope  is  man- 
made  law.  Law  determines  the  particular  relations  of 
man  to  man.  Since  law  is  based  upon  economics,  it 
cannot  permanently  and  successfully  run  counter  to 
economic  principles.  Based  upon  law  and  considerably 
narrower  in  its  scope  is  accounting,  which  defines  most 
of  the  particular  relations  of  man  to  man.  As  already 
stated,  standing  at  the  apex  of  this  pyramid  is  the 
accountant,  who  applies  the  rules  of  accounting  with  a 
knowledge  of  law  and  an  appreciation  of  economics. 

The  professional  accountant  must  be  able  to  take 
any  modern  business  and  devise  for  it  a  system  of 
accounts  which  will  adequately  serve  its  accounting 
needs;  he  must  be  able  to  summarize  and  present  the 
financial  facts  shown  by  these  or  any  other  accounting 
records  in  approved  statement  form,  and  be  able  to 
verify  such  statements  when  made  by  other  persons; 
he  must  be  able  to  examine  books  of  account  so 
as  to  ascertain  whether  or  not  they  have  been  correctly 
kept,  what  the  profits  and  losses  have  been,  and  whether 
or  not  cash  or  any  other  asset  has  been  lost  or  stolen. 
He  must  be  able  to  do  all  these  things  in  such  a  way 
that  those  untrained  in  the  art  of  accountancy  will 
readilv  understand  the  conclusions  he  draws  and  will 


14  FUNDAMENTAL  PRINCIPLES 

have  confidence  in  the  soundness  of  his  judgment,  the 
correctness  of  his  interpretations,  and  the  impartiality 
of  his  conclusions. 

10.    Public  Accountants 

Constructive  accounting  and  auditing  must  usually 
be  done  by  professional  accountants  who  perform  such 
work  for  any  business  which  may  engage  them,  re- 
ceiving a  fee  in  return  which  is  usually  fixed  at  a  rate 
per  diem.  Such  men  are  sometimes  called  expert 
accountants,  but  a  better  name  and  one  more  generally 
used,  is  that  of  public  accountants.  Practically  in  all 
states  laws  have  been  passed  which  permit  public  ac- 
countants to  take  an  examination  given  by  a  state  board. 
If  the  accountant  passes  this  examination  and  complies 
with  certain  legal  requirements  concerning  preliminary 
education,  age,  and  experience,  the  laws  designate  him 
as  a  certified  public  accountant. 

To  provide  the  public  with  a  further  certification, 
the  leading  accountants  throughout  the  country  are 
organized  in  an  association  known  as  the  American  Insti- 
tute of  Accountants.  This  body  conducts  its  own  exam- 
inations and  admits  to  membership  all  successful  candi- 
dates whether  or  not  they  have  been  certified  by  any  of 
the  states. 

Any  person  may  call  himself  a  public  accountant  or 
an  expert  accountant,  or  may  use  any  other  similar 
title  which  does  not  imply  certification.  But  no  person 
is  permitted  to  call  himself  a  certified  public  accountant 
unless  he  has  passed  the  state  examination  and  has  com- 
plied with  the  other  legal  requirements.  It  is  thus  evi- 
dent that  there  is  no  way  of  ascertaining,  from  the  title 


MODERN  ACCOUNTANCY  15 

assumed  by  an  accountant  who  is  not  certified,  whether 
or  not  he  is  competent  to  do  work  he  undertakes  to  do. 
Needless  to  say,  every  certified  accountant  is  no  more 
assuredly  competent  than  every  lawyer  or  doctor  is 
assuredly  competent,  but  certification  by  state  law  or 
admission  to  the  American  Institute  of  Accountants 
fixes  a  standard  by  which  ability  may  prima  facie  be 
gauged. 


CHAPTER    II 
PRELIMINARY  INFORMATION 

1.    Essential  Terms 

Every  vocation  has  certain  words  and  terms  peculiar 
to  its  practice.  Sometimes  these  are  new  words  coined 
to  fill  the  need.  More  often  they  are  words  already  in 
use  that  are  taken  over  and  given  a  special  meaning 
remote  from  their  common  acceptation.  The  word 
"bookkeeping"  and  the  word  "account"  have  both  been 
borrowed  in  this  way  and  given  a  purely  technical 
meaning. 

A  "bookkeeper"  is  not  a  keeper  of  books — a  libra- 
rian— but  instead,  one  who  records  financial  transac- 
tions, which  work  is  called  "bookkeeping."  An  "ac- 
count" is  not  a  description  of  something  that  has  hap- 
pened, but  an  orderly  record  of  values  paid  to  or  re- 
ceived from  a  particular  person  or  relating  to  a  tangible 
or  intangible  thing.  The  books  in  which  such  records 
are  kept  are  called  "books  of  account"  and  the  man  who 
is  trained  in  the  correct  method  of  recording  financial 
transactions,  grouping  them  into  accounts,  classifying 
these  accounts  according  to  their  nature,  and  then  com- 
paring and  analyzing  their  results,  is  called  "an  account- 
ant." An  accountant  differs  from  a  bookkeeper  in  that 
he  possesses  or  is  assumed  to  possess  a  higher  degree  of 
skill  and  ability.  The  exact  line  of  demarcation  be- 
tween the  two  cannot  be  rigidly  drawn. 

One  definition  of  "accountancy"  has  already  been 

16 


PRELIMINARY  INFORMATION  17 

given  in  Chapter  I.  Another  definition  is  that  it  is  the 
science  and  practice  of  accounts. 

An  "account"  is  an  orderly  statement  of  the  "debits" 
and  "credits"  pertaining  to  financial  transactions  with 
a  particular  person  or  concerning  some  subject  matter 
of  the  particular  enterprise. 

A  "debit"  is  an  entry  (some  value  entered  in  a  book- 
keeping record)  against  a  person  and  in  favor  of  the 
business  or  against  something  of  value  or  some  expense 
and  for  the  use  of  this  thing  in  the  business.  "Dr."  is 
the  symbol  sometimes  used  by  bookkeepers  to  designate 
a  debit  entry.  "Mark  Holden,  Dr.,  $10"  would  mean 
that  the  business  had  paid,  or  in  some  way  transferred 
to,  Mark  Holden  value  to  the  amount  of  $10,  and  that 
this  amount  was  "charged"  or  debited  against  him  in 
favor  of  the  business.  "Advertising,  Dr.  $50,"  would 
mean  that  $50  had  been  paid  or  an  obligation  to  pay  that 
amount  had  been  incurred  for  advertising  for  the  use  of 
the  business  and  that  this  amount  was  charged  against 
advertising  by  making  a  debit  entry  on  the  business 
books. 

A  "credit"  is  an  entry  in  the  records  in  favor  of 
some  person  and  against  the  business,  or  to  record  an 
income  of  the  business.  "Cr."  is  the  bookkeeping 
symbol  to  indicate  such  an  entry.  "Anson  Merritt, 
Cr.  $25,"  means  that  Mr.  Merritt  has  paid  or  has 
given  goods  or  services  to  that  amount  and  that  he 
has  been  credited  on  the  books.  It  shows  that  the  busi- 
ness owes  him.     (See  page  176.) 

The  foregoing  definitions  are  of  necessity  incom- 
plete. They  will  be  amplified  as  the  need  arises  with 
the  explanation  of  different  kinds  of  financial  transac- 


18  FUNDAMENTAL  PRINCIPLES 

tions.  Other  technical  words  and  terms  are  used  in 
accountancy,  often  in  a  sense  peculiar  to  the  subject. 
Their  meaning  must  be  explained  and  thoroughly 
grasped  if  the  subject  is  to  be  intelligible.  Therefore, 
this  and  the  following  two  chapters  discuss  the  most 
common  of  these  words  and  expressions  and  to  some 
extent  illustrate  the  business  situations  in  which  they 
are  ordinarily  used.  Other  words  and  terms  peculiar 
to  special  phases  of  accounting  will  be  explained  in  the 
text  as  they  are  used. 

2.  Definition  of  Sole  Proprietorship 

There  are  three  principal  forms  of  business  organi- 
zation: (1)  the  sole  proprietorship;  (2)  the  partner- 
ship; (3)  the  corporation. 

The  simplest  of  these  three  is  the  business  owned 
and  managed  by  one  person  conducting  business  by 
himself.  While  large  business  enterprises  sometimes 
belong  to  sole  proprietors,  this  form  of  business  organi- 
zation is  usually  confined  to  professional  practices  and 
the  conduct  of  small  businesses. 

3.  Definition  of  Partnership 

An  organization  of  two  or  more  persons  by  agree- 
ment, oral  or  written,  whereby  they  conduct  a  business 
jointly,  sharing  their  profits  and  losses  in  certain  pro- 
portions, constitutes  a  partnership  and  the  persons  form- 
ing it  are  partners.  A  partnership  is  generally  called 
a  firm.  Thus,  if  Albert  Curtis  and  John  Gould  agree 
to  conduct  business  together,  each  having  some  sort  of 
proprietory  interest  in  it,  they  form  a  partnership. 
They  would  then  probably  call  their  organization  a 


PRELIMINARY  INFORMATION  19 

"firm,"  and  other  persons  who  do  business  with  them 
would  use  the  same  word,  because  it  is  shorter  and  easier 
to  say  than  "partnership."  Similarly,  each  partner 
would  be  known,  colloquially,  as  a  member  of  the  firm. 
It  is  incorrect  to  use  the  word  "firm"  in  connection  with 
any  form  of  business  organization  other  than  the  part- 
nership. 

4.  Definition  of  Corporation 

A  corporation  is  a  group  of  individuals,  usually 
three  or  more,  authorized  by  law  to  act  in  certain  re- 
spects as  one  person.  A  corporation  is  often  defined  as 
an  artificial  being  created  by  law  and  composed  of  in- 
dividuals acting  under  a  common  name.  The  word 
"company"  is  applied  to  a  corporation  in  the  same  way 
that  the  term  "firm"  is  applied  to  a  partnership  and  for 
the  same  reasons.  Thus,  if  Albert  Curtis,  John  Gould 
and  Horace  Hull  organize  a  corporation,  they  would 
generally  refer  to  their  organization  as  a  "company." 
They  would  not  be  members  of  a  firm;  they  would  be 
stockholders  in  a  company  and  probably,  although  not 
necessarily,  officers  therein. 

5.  Relation  Between  Proprietor  and  Business 

Whatever  form  of  organization  may  be  used,  it 
should  be  borne  in  mind  that  for  accounting  purposes 
the  business  must  be  considered  as  an  entity  apart  from 
the  proprietor.  In  other  words,  the  proprietor  must 
be  treated  as  if  he  were  completely  detached  from  the 
working  organization,  but  owning  certain  rights  and  in- 
curring certain  obligations  in  connection  with  the  busi- 
ness.    This  status  of  the  proprietor  is  clearly  defined 


90  FUNDAMENTAL  PRINCIPLES 

in  the  corporate  form  of  organization,  where  the  pro- 
prietor, as  a  stockholder,  is  in  every  respect  a  different 
person  from  the  corporation.  It  is  less  clearly  marked, 
but  no  less  important,  in  the  partnership  and  the  sole 
proprietorship. 

Some  writers  explain  the  proprietor's  distinctive 
relation  to  the  business  by  considering  the  bookkeeper 
as  representing  the  business  and  thus  as  accountable  to 
the  proprietor.  This  seems  fanciful  and  without  merit 
because  the  bookkeeper  or  the  accounting  department 
has  no  title  to  any  of  the  business  property  and  is  under 
no  obligations  except  those  of  employees.  The  business 
should  be  regarded  as  a  distinct  entity  without  con- 
sidering any  person  within  its  organization  as  its  repre- 
sentative. 

Statements  made  throughout  this  volume  to  the 
effect  that  "the  business"  owns  certain  property  or  is 
under  certain  obligations  are  based  upon  this  distinction 
between  the  proprietor  and  the  business.  As  a  matter 
of  law,  in  some  of  the  instances  the  title  would  be  vested 
in,  and  the  obligation  imposed  upon,  the  proprietor 
himself  personally;  but  correct  accounting  is  facilitated 
by  keeping  in  mind  this  conception  of  the  business  as  a 
distinct  entity,  i.e.,  as  having  a  separate  existence  and 
thus  being  capable  of  holding  title  to  property  and  ful- 
filling obligations. 

6.     Definition  of  Assets 

The  object  of  conducting  business  is  to  procure 
more  property,  more  things  of  value,  than  the  pro- 
prietor has  when  he  begins  business.  The  things  of 
value  or  property  owned  by  the  business  are  called 


PRELIMINARY  INFORMATION  21 

"assets. "  An  asset  may  be  anything  of  value,  such  as 
cash,  merchandise,  horses,  wagons,  machinery,  tools, 
typewriters,  buildings,  and  land.  To  constitute  an 
asset,  the  property  in  question  must  be  owned  by  the 
business.  If  in  a  shirt-waist  factory  the  sewing  machines 
are  rented,  they  do  not  constitute  assets  of  the  business, 
because  while  they  are  things  of  value  used  in  the  busi- 
ness, they  are  not  owned  by  it.  They  would,  however, 
be  assets  of  the  sewing  machine  company  which  owned 
them. 

If  the  business  sold  goods  on  credit,  the  person  buy- 
ing them  would  owe  the  business  and  would  be  a  debtor. 
The  amount  he  owed  would  be  an  asset  of  the  business. 

Assets  are  sometimes  called  "resources,"  but  the 
latter  term  is  not  in  common  use,  and  for  this  reason  is 
not  employed  in  this  book. 

7.     Definition  of  Liabilities 

When  a  business  secures  assets  or  services  of  some 
sort  in  exchange  for  cash  or  other  property,  it  is  said 
to  buy  or  purchase  the  assets  or  services  acquired,  and 
when  it  delivers  the  cash  or  other  assets  in  exchange  to 
the  person  from  whom  the  purchase  was  made,  it  is  said 
to  pay  for  them.  Xow  in  the  conduct  of  business  it  is 
not  customary  always  to  pay  for  assets  or  services  at 
the  exact  time  of  purchase.  The  exchange  may  be  com- 
pleted later ;  that  is,  payment  may  be  made  on  the  next 
day  or  at  some  future  time.  In  that  event  the  purchase 
is  said  to  be  "on  credit."  The  length  of  time  for  which 
credit  is  thus  extended  is  fixed  by  agreement  between 
the  parties  to  the  purchase,  and  may  vary  from  one  day 
to  six  months  or  more. 


22  FUNDAMENTAL  PRINCIPLES 

When  a  purchaser  buys  on  credit,  the  person  from 
whom  he  buys  is  called  a  "creditor"  and  the  obligation 
to  pay  imposed  on  the  purchaser  is  called  a  "liability." 
Thus,  liability  may  be  defined  as  an  obligation  imposed 
upon  a  person  to  complete  an  exchange ;  in  other  words, 
to  pay  for  services  secured  or  assets  purchased. 

When  a  business  pays  to  settle  a  liability,  both  the 
liability  and  the  cash  or  other  asset  which  pays  it  are 
canceled  as  far  as  the  business  is  concerned.  The 
liability  ceases  to  exist  and  the  asset,  i.e.,  the  cash  paid, 
goes  out  of  the  business. 

8.  Definition  of  Capital 

The  assets  of  a  business  are  what  it  has.  The  liabili- 
ties of  a  business  are  what  it  owes.  If  a  business  is 
solvent,  its  assets  exceed  its  liabilities,  i.e.,  the  business 
owns  enough  to  pay  all  its  debts  and  have  something 
left  over.  The  amount  so  left  over,  the  excess  of  assets 
over  the  liabilities  is  "the  capital."  The  essential 
nature  of  capital  remains  the  same  regardless  of  the 
form  of  organization.  Capital  is  the  excess  of  assets 
over  liabilities,  whether  a  business  be  a  sole  proprietor- 
ship, a  partnership,  or  a  corporation.  The  term  is  an 
important  one  and  the  foregoing  is  a  partial  definition 
solely  from  the  bookkeeping  standpoint.  The  subject 
will  be  treated  at  greater  length  in  the  next  chapter. 

Accounting  methods  of  recording  capital  and  capital 
changes  will  be  presented  in  later  chapters. 

9.  Recording  Business   Information 

In  order  to  collect  information  about  the  business 
so  that  it  will  be  available  for  the  proprietor,  or  for  an 


PRELIMINARY  INFORMATION  23 

outside  person  who  has  a  legitimate  reason  for  needing 
the  information,  records  known  as  books  of  account  are 
kept.  The  recording  of  such  information  is  known  as 
bookkeeping.  The  nature  of  the  desired  information 
may  be  summarized  as  follows: 

1.  Information  concerning  the  financial  condition 

of  the  business;  that  is,  assets,  liabilities,  and 
capital. 

2.  Information  concerning  the  results  of  operat- 

ing the  business;  in  other  words,  its  profits 
and  losses. 

Information   of   the   first   kind   will   answer    such 
questions  as  these : 

(a)  What  kinds  of  property  constitute  the  assets 

and  what  is  the  value  of  each? 

(b)  What  liabilities   does  the  business   owe,   to 

whom  and  when  should  they  be  paid? 

(c)  Are  there  any  contingent  liabilities,  that  is, 

liabilities  which  may  become  payable  in 
certain  contingencies  or  if  certain  things 
come  to  pass? 

(d)  Do  the  assets  exceed  in  value  the  liabilities; 

is  there  any  capital  in  the  business  ? 

(e)  Is  there  sufficient  cash  or  other  assets  which 

in  the  ordinary  course  of  business  will  be 
converted  into  cash  to  meet  liabilities  which 
must  be  paid  in  the  immediate  future? 

(f )  Will  the  business  be  able  to  meet  all  its  liabili- 

ties as  they  become  payable? 

Information  of  the  second  kind  will  answer  ques- 
tions such  as  these: 


24  FUNDAMENTAL  PRINCIPLES 

(a)  How  much  profit  has  been  made  or  how  much 

loss  has  been  incurred  by  the  business  in  a 
given  period? 

(b)  What  sources  of  income  has  the  business;  in 

other  words,  what  things  does  it  sell,  or 
what  kinds  of  service  does  it  render? 

(c)  How  much  is  the  income  from  each  source? 

(d)  What  are  the  expenses  of  the  business? 

10.    Primary  Purposes  of  Bookkeeping  Records 

Information  concerning  both  financial  condition 
(assets  and  liabilities)  and  the  results  of  operation  (in- 
come and  expense)  is  needed  by  the  proprietor  to 
enable  him  to  manage  the  business  and  plan  for  its 
future  in  the  most  effective  way. 

Information  of  the  first  kind  is  needed  principally 
to  help  him  finance  the  business,  to  provide  for  the  pay- 
ment of  liabilities  as  they  mature,  and  to  conserve  the 
assets. 

Information  of  the  second  kind  is  necessary  to  enable 
him  to  determine  what  lines  of  business  activity  are 
profitable  (if  the  business  has  more  than  one  line),  and 
how  each  kind  of  expense  compares  with  the  income  it 
is  intended  to  produce.  He  needs  it  also  to  compare 
expenses  of  the  current  period  with  those  of  a  preceding 
period,  and  to  estimate  what  the  expenses  of  a  succeed- 
ing period  are  likely  to  be. 

The  same  information  of  both  kinds  may  be  needed 
by  an  outsider  if  he  is  asked,  for  example,  to  sell  mer- 
chandise to  the  business  on  credit  or  to  lend  money  or 
to  invest  money  or  other  assets  therein. 


PRELIMINARY  INFORMATION  25 

11.    Definition  and  Use  of  Statements 

Although  information  about  the  business  is  col- 
lected in  books  of  account  where  it  can  be  found  when 
needed,  such  information  is  usually  presented  to  the 
proprietor  or  other  persons  entitled  to  it  by  means  of 
written  statements.  Such  a  statement  may  be  defined 
as  a  written  presentation  of  business  information  in 
condensed  and  summary  form.  Statements  are  usually 
prepared  directly  from  the  books  of  account  and  when 
necessary  may  contain  any  further  information  not  re- 
corded in  such  books  which  may  be  needed  to  supple- 
ment or  make  clear  the  figures  taken  from  the  books. 

Why  is  it  necessary  to  present  statements  to  the 
proprietor  or  an  outside  person?  Why  cannot  they 
get  the  information  by  consulting  the  books  of  account? 
In  the  first  place  the  proprietor  rarely  has  time  to  "dig" 
the  information  he  needs  out  of  the  books,  which 
usually  go  into  much  detail  and  in  a  big  business  are 
voluminous.  Then  also  he  may  not  understand  the 
methods  of  bookkeeping  and  so  cannot  properly  inter- 
pret the  records  as  they  stand  on  the  books.  Further, 
he  may  desire  the  bookkeeping  figures  in  some  con- 
venient and  condensed  form  in  order  to  study  them 
away  from  the  office. 

All  these  reasons  why  such  information  cannot  con- 
veniently be  secured  by  the  proprietor  directly  from  the 
books  apply  also  in  the  case  of  outside  persons.  In  addi- 
tion the  proprietor  may  not  wish  to  give  such  persons 
free  and  unlimited  access  to  his  books.  In  some  cases  the 
outsider  is  entitled  only  to  certain  specific  information 
and  not  to  all  that  the  books  show.  Frequently  the  office 
is  too  busy  to  permit  such  an  interruption  of  its  routine 


26  FUNDAMENTAL  PRINCIPLES 

as  would  be  caused  by  an  inspection  of  the  books  by  an 
outside  person.  So  it  is  customary  to  present  to  the 
proprietor  and  to  such  outsiders  as  may  be  entitled 
thereto,  business  information  in  the  form  of  statements 
prepared  from  the  books  of  account. 

The  statement  should  present  the  information  in 
convenient  form  and  be  so  arranged  that  the  reader  can 
easily  understand  it.  In  this  volume  the  preparation  of 
simple  statements  is  set  forth.  In  Volumes  II  and 
IV  the  form  and  arrangement  of  more  complicated 
statements  are  shown.  The  preparation  of  adequate 
statements  is  a  difficult  art,  the  successful  practice  of 
which  requires  analytical  ability  in  determining  the 
facts  and  considerable  ingenuity  in  arranging  them  so 
as  to  present  clearly  just  what  the  reader  of  the  state- 
ment should  know. 


REVIEW   QUESTIONS 


1.    Explain  the  terms: 
Accountancy 
Account 
Debit 
Credit 
Creditor 
Proprietor 
Sole  proprietorship 
Partnership 
Corporation 
Asset 
Liability 
Capital 
Statement 


PRELIMINARY  INFORMATION  27 

2.  What  are  the  three  forms  of  business  organization  mentioned 

above?     Is  there  any  other  form? 

3.  What  relationship  is  shown  on  the  bookkeeping  records  between 

a  business  and  its  proprietor? 

4.  Name  three  things  not  mentioned  in  this  chapter  which  may  be 

assets. 

5.  Give  an  illustration  not  mentioned  in  this  chapter  of  a  transac- 

tion which  would  result  in  the  creation  of  a  liability. 

6.  What  two  kinds  of  information  about  a  business  are  needed  by 

the  proprietor? 

7.  Suggest  some  questions  about  a  business  which  might  be  asked 

by  an  outsider  who  was  requested  by  the  proprietor: 

(a)  To  invest  money  in  the  business. 

(b)  To  sell  goods  to  the  business  on  credit. 

(c)  To  lend  money  to  the  business. 

8.  (a)   How  is  information  about  a  business  collected  and  recorded? 

(b)  How  is  it  presented  to  the  proprietor  or  any  other  person 

entitled  to  it? 

(c)  Why  is  it  necessary  to  present  it  in  the  way  you  mention? 


CHAPTER   III 

CAPITAL 

1.    Accounting  Definition  of  Capital 

At  the  outset  of  a  business  venture  the  proprietor 
himself  generally  contributes  some  of  his  private  assets 
to  be  used  in  it  and  he  may  make  similar  contributions 
at  any  time.  Thereafter  most  of  the  assets  acquired  are 
bought  from  trade  creditors  or  procured  from  other 
persons  outside  the  organization.  Suppose,  for  ex- 
ample, that  a  proprietor  invests  $10,000  of  his  private 
cash  in  a  business.  In  that  event  the  business  would 
acquire  an  asset  of  $10,000,  but  would  incur  no  liability 
in  connection  with  it — that  is,  no  obligation  to  pay 
$10,000  or  its  equivalent  to  any  creditor.  It  would  be 
obliged,  however,  when  the  business  terminated  to 
account  to  the  proprietor  for  the  $10,000,  and  this  obli- 
gation on  the  books  to  account  to  him  for  assets  re- 
ceived is  designated  as  "capital." 

The  capital,  which  in  this  case  would  be  $10,000, 
must  not  be  confused  with  the  cash  amount  of  $10,000. 
The  latter  is  an  asset  belonging  to  the  business,  in  no- 
wise distinguished  from  goods  in  stock  or  other  assets; 
the  capital  is  the  obligation  t  j  account  to  the  proprietor 
for  his  investment,  or  what  is  left  of  it,  when  the  busi- 
ness is  wound  up  and  all  debts  have  been  paid. 

The  proprietor  may  contribute  any  kind  of  assets; 
for  example,  he  may  set  aside  from  his  private  property 
for  use  in  the  business  $10,000  in  cash,  furniture  worth 

28 


CAPITAL  29 

$500,  and  machinery  worth  $20,000.  The  capital  then 
would  be  $30,500. 

If  more  cash  is  needed,  it  may  be  necessary  to 
borrow  it  from  a  bank  or  other  outside  source.  Such 
loans,  which  are  usually  for  short  periods  with  frequent 
renewals,  but  which  may  be  for  periods  of  a  year  or 
more,  do  not  increase  the  capital.  If  the  business,  in 
the  case  suggested  above,  needs  $5,000  more  cash  and 
borrows  it  from  a  bank,  the  bank  becomes  a  creditor. 
While  the  assets  are  increased  to  $35,500,  a  liability  of 
$5,000  has  been  incurred.  The  amount  for  which  the 
business  is  accountable  to  the  proprietor  remains 
$30,500.  The  assets  exceed  this  amount  by  $5,000,  but 
the  obligation  to  account  for  this  $5,000  is  not  to  the 
proprietor,  but  to  the  bank,  a  creditor. 

Thus  capital  may  be  defined  as  the  excess  of  assets 
over  liabilities.  It  is  not  represented  by  any  specific 
assets;  it  is  merely  the  obligation  of  the  business  to 
account  to  the  proprietor  for  the  value  of  the  assets  in 
excess  of  the  amount  needed  to  pay  creditors,  or,  in 
other  words,  the  net  ownership  of  the  proprietor  in  the 
business.  Capital  is  sometimes  called  "net  worth"  but 
this  term  is  not  commonly  used.  It  is  sometimes  called 
"investment"  but  this  word  is  generally  used  to  mean  a 
purchase,  say,  of  stocks  or  bonds,  made  with  a  portion 
of  the  non-trading  funds  of  a  business  concern.  Hence, 
this  term  will  not  be  used  here  to  mean  capital,  although 
a  proprietor  may  properly  be  said  to  invest  his  private 
assets  in  his  business. 

2.     Economic   Definition  of  Capital 

Accountants  should  learn  the  definition  of  capital 


30  FUNDAMENTAL  PRINCIPLES 

from  the  point  of  view  of  the  economist,  which  differs 
essentially  from  that  of  the  accountant.  Economics  is 
the  science  which  treats  of  man's  activity  in  the  acquisi- 
tion, distribution,  and  consumption  of  wealth.  The 
economist  is  interested  in  studying  the  results  which  can 
be  obtained  by  the  use  of  money  or  any  other  property 
in  business.  He  studies  business  with  the  object  of 
ascertaining,  for  example,  how  much  income  should 
be  produced  by  the  use,  under  certain  conditions,  of 
a  given  amount  of  money  or  other  property.  He  is 
not  interested  in  the  source  of  the  money  or  property 
used  in  an  enterprise,  whether  it  is  contributed  by  the 
proprietor  or  borrowed  from  persons  outside  the  busi- 
ness organization  which  is  under  examination.  He  is 
interested  only  in  the  total  amount  of  money  or  other 
property  which  is  used  to  produce  income,  and  which 
he  calls  capital.  From  the  economist's  point  of  view 
capital  is  the  total  wealth,  that  is,  the  total  property  of 
the  business  used  to  produce  more  wealth  or  income. 
For  example,  in  the  illustration  given  the  capital  from 
the  economist's  point  of  view  would  be  $35,500. 

3.    The  Accountant's  Viewpoint 

Now,  the  accountant  rarely  studies  business  in  an 
abstract  way;  he  usually  studies  a  particular  business 
and  that  principally  to  determine  or  define  the  rights 
and  obligations  of  the  various  persons  interested  in  or 
connected  with  it;  that  is,  to  determine  the  equities. 
The  accountant  desires  to  ascertain  the  accountability 
of  persons  to  the  business  and  of  the  business  to  persons. 
He  is  interested  chiefly  in  learning  the  extent  of  the 
obligations  of  persons  to  the  business,  as  indicated  by 


CAPITAL  31 

accounts  with  persons  indebted  to  the  business,  termed 
in  bookkeeping  parlance  "accounts  receivable";  the 
extent  of  the  obligations  of  the  business  to  persons,  as 
indicated  by  accounts  with  persons  who  have  given 
credit  to  the  business,  and  which  are  termed  "accounts 
payable";  and  finally  (in  a  sense)  the  extent  of  the 
obligation  of  the  business  to  the  proprietor — how  much 
the  proprietor  really  owns  in  the  business  after  making 
provision  for  the  payment  of  accounts  payable.  In  other 
words,  the  accountability  of  the  business  to  the  pro- 
prietor, or  his  ownership  therein  after  provision  has  been 
made  for  the  payment  of  all  accounts  payable  or  liabil- 
ities, is  the  capital.  Thus,  capital  from  the  accountant's 
point  of  view,  which  will  be  that  of  this  book,  is  the 
excess  of  assets  over  liabilities;  in  the  example  given  it 
would  be  $30,500. 

4.    Definition  of  Profit 

Earlier  in  this  chapter  it  was  stated  that  the  object 
of  conducting  business  is  to  procure  more  assets  than  the 
proprietor  owns  when  he  begins  business.  At  that 
point  the  subject  of  liabilities  had  not  been  introduced. 
Now  that  liabilities  have  been  discussed,  the  statement 
of  the  object  of  conducting  business  may  be  modified 
somewhat,  for  any  new  liabilities  incurred  must  be 
deducted  from  the  value  of  new  assets  in  order  to 
determine  whether  or  not  the  object  of  conducting  the 
business  has  been  attained.  This  object,  stated  more 
exactly,  is  to  secure  an  increase  in  assets  that  are  held 
free  and  clear;  assets  that  have  no  liabilities  offsetting 
them.  In  other  words,  the  object  is  to  conduct  the  busi- 
ness so  as  to  increase  the  original  capital. 


82  FUNDAMENTAL  PRINCIPLES 

An  increase  in  capital,  other  than  that  contributed 
by  the  proprietor,  is  called  a  profit.  For  example,  if 
the  proprietor  invests  $10,000  in  a  business  and  after 
conducting  it  for  a  year  has  $15,000  free  and  clear  of 
liabilities  without  having  made  any  further  contribu- 
tion, without  having  withdrawn  any  money  or  other 
assets  for  his  personal  use,  and  without  having  imposed 
on  the  business  any  of  his  personal  liabilities,  the  busi- 
ness has  made  a  profit  of  $5,000. 

Profit  has  sometimes  been  defined  as  the  amount  of 
earnings  left  after  deducting  all  expenses  and  losses; 
but  that  definition  seems  to  limit  profits  to  those  secured 
from  the  operation  of  the  business,  whereas  they  might 
also  be  secured  in  other  ways.  Later  in  this  book  the 
nature  of  profits  will  be  considered.  At  this  point  it  is 
sufficient  merely  to  call  attention  to  the  fact  that  profits 
or  income  are  not  limited  to  earnings  made  by  the  busi- 
ness in  its  ordinary  operation,  but  really  include  all  in- 
creases in  capital  not  contributed  by  the  proprietor. 
For  example,  if  an  asset  which  was  not  originally 
bought  for  sale,  such  as  a  machine  used  in  manufactur- 
ing, is  sold  for  more  than  it  cost,  the  amount  of  such 
excess  is  a  profit. 

5.    Definition  of  Loss 

A  loss,  which  is  the  converse  of  a  profit,  may  be  in- 
curred in  either  of  two  ways.  It  may  be  incurred  in  the 
ordinary  conduct  of  the  business  as  a  result,  for  instance, 
of  selling  goods  at  less  than  cost,  or  it  may  be  caused  by 
a  sale  of  some  property  not  intended  for  sale  at  an 
amount  below  cost.  Loss  may  be  defined  as  any  decrease 
in  capital  not  due  to  the  proprietor's  withdrawals. 


CAPITAL  33 

6.  Withdrawals 

What  the  proprietor  withdraws  from  the  business 
is  some  asset,  which  is  usually  money  but  which  may  be 
material  or  articles  of  any  sort.  Frequently,  it  consists 
of  the  merchandise  in  which  the  business  deals,  but 
which  the  proprietor  can  use  personally — for  example, 
groceries.  The  effect  is,  of  course,  to  reduce  capital 
because  the  withdrawals  reduce  assets  with  no  effect 
upon  liabilities. 

The  withdrawals  may  be  made  either  directly  by 
taking  out  the  asset,  or  indirectly  by  charging  the  pro- 
prietor's personal  bills  to  the  business.  They  may  occur 
weekly,  monthly,  or  at  any  other  time ;  for  instance,  when 
the  proprietor  withdraws  cash  to  pay  a  personal  ex- 
pense such  as  a  life  insurance  premium.  Many  sole 
proprietors  and  partners  regularly  charge  their  per- 
sonal drawings  or  a  certain  part  of  them  as  salaries  and 
consider  those  drawings  as  expenses  of  conducting  busi- 
ness. Later  in  the  book  there  will  be  a  discussion  of 
when,  if  at  all,  the  drawings  of  a  sole  proprietor  or  of 
members  of  a  partnership  may  be  considered  in  lieu  of 
salaries  paid  for  managerial  services.  At  this  point  it 
is  better  to  consider  all  personal  drawings  by  the  pro- 
prietor as  withdrawals  of  profits  or  reductions  of 
capital,  which  have  no  effect  upon  the  operation  of  the 
business  because  they  are  not  expenses. 

7.  Definition  of   Deficit 

It  is  no1;  correct  to  define  capital  as  the  difference 
between  assets  and  liabilities,  because  liabilities  may, 
and  sometimes  do,  exceed  assets,  and  in  that  case  the 
difference  between  them   is  not  capital.     An  excess 


34  FUNDAMENTAL  PRINCIPLES 

of  liabilities  over  assets  is  termed  "deficiency"  or 
"deficit."  It  is  the  reverse  of  capital  and  is  thus  a  state 
of  fact  existing  at  a  particular  time.  For  example,  if 
on  December  31,  1919,  the  liabilities  of  a  business  were 
$12,000  but  its  assets  were  only  $11,000,  there  would 
be  a  deficit  at  that  time  of  $1,000.  Deficit  should  not 
be  confused  with  loss  because  loss  instead  of  being  a 
state  of  fact  at  a  particular  time  is  the  result  of  operat- 
ing a  business  so  that  during  some  period  of  time  the 
expenses  exceed  the  income.  Notwithstanding  a  loss 
during  the  year  ending  December  31,  1919,  there  might 
have  been  capital  in  the  business  both  at  the  beginning 
and  at  the  end  of  the  year.  Also  there  might  have  been 
a  profit  during  that  year,  although  there  was  a  deficit 
at  the  beginning  and  at  the  end  of  it. 

At  the  beginning  of  a  business  there  cannot  be  a 
deficit  because  every  original  asset  must  come,  as  has 
been  explained,  from  a  creditor  or  the  proprietor.  If 
an  asset  comes  from  the  proprietor  it  creates  capital. 
If  it  comes  from  a  creditor  a  liability  is  created.  But 
this  liability  is  offset  by  the  asset  itself,  so  that  at  the 
beginning  there  must  be  either  capital  or  an  exact 
balance  between  assets  and  liabilities;  there  cannot  be 
a  deficit.  After  a  business  has  been  in  operation  a 
deficit  may  be  caused  by  a  loss  of  assets  due  to  opera- 
tion or  a  withdrawal  of  assets  in  excess  of  the  amount 
of  capital  standing  to  the  credit  of  the  proprietor. 

8.    Summary  of  Capital   Changes 

The  following  analysis  of  changes  in  capital  due  to 
profits,  losses,  contributions,  and  withdrawals  shows  how 
assets  come  into  and  go  out  from  a  business. 


CAPITAL  35 

An  asset  may  come  from  any  one  of  three  sources: 

1.  It  may  come  from  the  proprietor  as  a  contri- 

bution of  capital. 

2.  It  may  come  from  persons  other  than  the  pro- 

prietor. In  that  case  a  liability  is  created  in 
favor  of  the  person  from  whom  it  comes  or 
else  an  asset  is  delivered  in  exchange. 

3.  It  may  be  procured  as  a  result  of  a  profit  made 

by  the  business,  as  for  instance,  when  an 
asset  is  exchanged  for  one  of  greater  value. 
In  that  case  capital  is  increased. 

An  asset  can  pass  out  from  the  business  in  any  one 
of  three  ways: 

1.  It  may  be  used  to  pay  a  liability;  both  the  asset 

and  the  liability  are  then  canceled,  and  there 
is  no  effect  on  capital. 

2.  It  may  disappear  as  a  result  of  a  loss  incurred 

by  the  business,  e.g.,  the  exchange  of  an  asset 
of  a  value  greater  than  that  of  the  one  re- 
ceived; or  it  may  be  used  to  pay  for  one  of 
the  expenses  of  the  business,  e.g.,  salaries  or 
rent. 

3.  It  may  be  withdrawn  by  the  proprietor  for  his 

personal  use.  Here  capital  will  be  decreased 
because  assets  are  decreased  and  liabilities 
are  in  no  way  affected. 

The  various  causes  of  changes  in  capital  which  have 
been  described  above  may  be  summarized  as  follows: 

1.    Capital  is  increased  by  new  assets  procured  as 
a  result  of  a  profit  made  by  the  business. 


36  FUNDAMENTAL  PRINCIPLES 

2.  Capital  is  increased  by  assets  contributed  by 

the  proprietor. 

3.  Capital  is  decreased  by  assets  which  disappear 

as' a  result  of  a  loss  incurred  by  the  business. 

4.  Capital  is  decreased  by  assets  withdrawn  by  the 

proprietor  for  his  personal  use. 

9.    Examples  of  Capital  Changes 

Many  transactions  in  actual  business  involve  more 
than  one  of  these  four  kinds  of  changes.  Such  trans- 
actions to  be  clearly  understood  and  properly  recorded 
should  be  analyzed  and  each  of  the  above  elements 
recognized  and  properly  treated.  Simple  examples  of 
each  kind  are  as  follows : 

1.  If  merchandise  costing  $100  be  sold  for  $150  in 
cash,  a  new  asset,  cash,  to  the  amount  of  $150  is  pro- 
cured in  place  of  the  former  asset.  An  additional  asset 
of  $50  is  acquired  by  the  business,  and  the  capital  is 
increased  by  that  amount  as  the  result  of  a  profit. 

2.  If  the  proprietor  invests  in  the  business  $1,000 
from  his  personal  funds,  the  capital  is  increased  by  the 
amount  of  this  new  asset. 

3.  If  merchandise  costing  $100  be  sold  for  $75  in 
cash,  a  new  asset,  cash,  to  the  amount  of  $75  is  pro- 
cured in  place  of  the  former  one.  There  would  thus 
be  a  disappearance  of  asset  value  to  the  amount  of 
$25  due  to  a  loss.  The  capital  is  decreased  by  the 
amount  of  the  asset  which  has  disappeared  because  of 
this  loss. 

4.  If  the  proprietor  withdraws  $2,000  in  cash  for 
his  personal  use,  capital  is  decreased  by  the  amount  of 
the  asset  withdrawn. 


CAPITAL  37 

REVIEW   QUESTIONS 

1.  Define  capital.     Is  capital  a  liability? 

2.  Distinguish  between  accounting  capital  and  economic  capital. 

3.  Define: 

(a)  Profit 

(b)  Loss 

(c)  Withdrawals 

(d)  Deficit 

4.  Draw  up  a  set  of  rules  helpful  to  a  bookkeeper  in  showing  him 

how  assets  and  liabilities  come  into  and  go  out  from  a  busi- 
ness, so  that  the  changes  in  the  capital  may  be  properly  in- 
dicated. 


CHAPTER   IV 
DOUBLE-ENTRY  BOOKKEEPING 

1.    Kinds  of  Bookkeeping 

In  Chapter  II  it  was  stated  that  business  information 
is  collected  in  books  of  account  and  that  the  making  of 
such  records  is  known  as  bookkeeping.  The  kind  of 
bookkeeping,  the  amount  of  detail  information,  and  the 
method  of  collecting  and  recording  it  vary  somewhat 
with  the  size  of  the  business  but  more  particularly 
with  the  kind  of  information  needed.  If  figures  as  to 
the  financial  condition  of  the  business  only  are  required, 
i.e.,  if  the  proprietor  merely  wants  to  keep  informed 
regarding  his  assets,  liabilities,  and  capital,  and  regard- 
ing the  total  changes  in  the  capital  from  time  to  time, 
the  bookkeeping  may  be  simple  and  the  method  known 
as  single-entry  bookkeeping  may  be  used.  ( See  Chap- 
ter XXXIV.)  But  if  the  proprietor  wants  informa- 
tion not  only  about  his  assets,  liabilities,  and  capital, 
but  also  about  the  details  of  his  profit  and  loss,  the 
system  of  bookkeeping  must  be  more  elaborate.  It 
must  show  all  that  single-entry  bookkeeping  shows  and 
much  more.  It  must  show  exactly  how  much  is  received 
from  each  source  and  how  much  it  costs  to  secure  each 
kind  of  income;  in  other  words,  what  the  expenses  are 
and  in  each  case  the  exact  amount.  Bookkeeping  which 
records  information  in  this  way  is  known  as  double- 
entry  bookkeeping,  and  such  is  the  method  most  gen- 
erally used  in  business  houses. 

38 


DOUBLE-ENTRY  BOOKKEEPING  39 

2.  Analysis  of  a  Business  Transaction 

Every  business  transaction  is  a  transfer  of  money  or 
money's  worth,  and  involves  two  essential  elements: 

1.  That  which  is  paid  or  given. 

2.  That  which  is  received  in  exchange  or  payment. 

Upon  receiving  money  or  money's  worth,  the  re- 
ceiver either  gives  money's  worth  or  money  in  exchange, 
or  else  becomes  obligated  to  do  so  at  some  future  time. 
For  example,  a  purchase  of  merchandise  may  be  for 
cash  or  on  credit  (on  account).  In  either  case  there 
is  a  transfer  of  money's  worth  (the  merchandise)  from 
seller  to  purchaser.  If  the  purchase  is  for  cash,  the 
purchaser  receiving  the  merchandise  gives  money  in 
exchange;  if  on  credit,  the  purchaser  becomes  obligated 
to  give  money  or  money's  worth  in  exchange  at  some 
future  time.  If  either  party  should  give  and  not  re- 
ceive, it  would  be  a  gratuitous  act  and  not  a  business 
transaction. 

Every  business  transaction  involves  one  or  more  of 
the  three  following  factors: 

1.  Money. 

2.  Money's  worth. 

3.  A  personal  obligation  to  give  money  or  money's 

worth  at  some  future  time. 

3.  Original  Entries  and  Their  Grouping  into  Accounts 

In  order  to  keep  a  chronological  record  of  the  busi- 
ness, each  transaction  as  it  occurs  should  be  "entered," 
that  is,  noted,  in  some  suitable  book.  Such  a  book  is 
designated  as  a  book  of  original  entry,  i.e.,  first  entry. 


40  FUNDAMENTAL  PRINCIPLES 

If  Clark  &  Fox  buy  goods  from  the  business  to  the 
amount  of  $35  on  account,  the  double  effect  would  be 
shown  by  an  entry  as  follows : 

Clark  &  Fox,   Dr $35.00 

Merchandise,  Cr $35.00 

In  addition  to  this  first  entry  of  each  transaction,  it 
is  necessary  for  practical  purposes  to  sort  or  classify 
these  original  entries  by  subjects  as  well  as  dates,  and 
this  is  accomplished  by  making  a  second  entry  of  each 
transaction  in  another  book  called  a  "ledger."  In  a 
ledger  all  the  entries  concerning  a  given  subject,  such 
as  cash  or  merchandise,  are  grouped  under  a  heading 
or  caption  which  is  the  name  of  the  subject,  whether 
it  be  a  person,  money,  kind  of  property,  or  anything 
which  is  money's  worth.  The  resulting  collection  of 
entries  concerning  a  given  person  or  subject  is  called 
an  "account." 

The  original  entries  shown  would  go  to  two  accounts 
in  the  ledger — the  personal  account  with  Clark  &  Fox, 
and  the  asset  or  property  account  with  "Merchandise." 
Every  transaction  will  be  finally  entered  in  two  ledger 
accounts,  on  the  debit  side  of  one  and  the  credit  side 
of  the  other.  Hence,  the  term  "double-entry  book- 
keeping." 

4.    The  Ledger 

The  ledger  is  the  essential  bookkeeping  record. 
The  other  books  merely  furnish  the  assembling  places 
in  which  are  gathered  and  sorted  the  transactions  as 
they  occur,  from  which  places  they  pass,  after  sorting, 
to  the  ledger.    If  the  functions  of  the  ledger  are  first 


DOUBLE-ENTRY  BOOKKEEPING  4*1 

explained,  the  uses  of  the  other  books  or  records  of 
original  entry  will  be  more  clearly  and  readily  under- 
stood. 

5.    Illustrative  Transactions 

To  illustrate  further  the  use  of  accounts,  the  follow- 
ing examples  are  given: 

1.  I  pay  $25  in  cash  for  goods  purchased.  Evi- 
dently goods  have  come  in  and  cash  has  gone  out. 
Therefore,  the  account  with  goods  is  increased 
(debited)  to  the  extent  of  $25,  and  the  account  with 
cash  must  be  decreased  (credited)  in  amount  $25.  The 
original  entry  would  be: 

Merchandise,   Dr $25.00 

Cash,    Cr $25.00 

2.  I  purchase  goods  from  Brown  &  Sharpe  on 
credit  for  $100.  As  before,  goods  come  in.  Merchan- 
dise account  is  increased  and  must  be  debited  $100.  I 
promise  Brown  &  Sharpe  to  pay  for  the  goods  some 
time  in  the  near  future ;  they  have  become  my  creditors. 
Therefore,  an  account  headed  "Brown  &  Sharpe"  must 
be  credited  for  $100.    The  original  entry  would  be: 

Merchandise,    Dr $100.00 

Brown  &  Sharpe,  Cr $100.00 

3.  I  give  Brown  &  Sharpe  my  30-day  note  for 
$100 ;  i.e.,  I  acknowledge  in  writing  my  indebtedness  to 
Brown  &  Sharpe  for  the  goods  purchased  from  them, 
and  I  promise  to  pay  them  cash  at  the  end  of  30  days. 
The  indebtedness  is  changed  on  my  books  from  a  mere 
memorandum  entry  (open  account),  to  a  written  obli- 


42  FUNDAMENTAL  PRINCIPLES 

gation  (notes  payable)  which  matures  in  30  days.    The 
original  entry  would  be: 

Brown  &  Sharpe,  Dr $100.00 

Notes  Payable,  Cr $100.00 

4.  I  sell  goods  for  cash  $75.  My  supply  of  goods 
has  been  decreased  and  I  have  increased  my  cash.  The 
original  entry  would  be : 

Cash,   Dr $75.00 

Merchandise,  Cr $75.00 

Since  for  every  debit  a  credit  of  an  equal  amount 
must  be  made,  or  for  every  credit  a  debit  of  an  equal 
amount,  the  sum  of  all  the  debits  entered  in  the  ledger 
must  equal  the  sum  of  all  the  credits  for  the  same  period. 
(See  also  "Rules  for  Journalizing,"  pages  175,  176.) 

6.    The  Form  of  an  Account 

Accounts  may  be  kept  in  many  different  forms.  The 
general  practice  is  to  divide  the  ledger  page  into  two 
parts — a  left-hand  half  and  a  right-hand  half,  each  half 
containing  a  separate  column  for  the  date,  the  explana- 
tion, and  the  amount.  The  following  form  shows  the 
second  and  third  transactions  mentioned  above  re- 
corded, i.e.,  "posted,"  in  the  proper  ledger  accounts.  It 
will  be  noticed  that  each  account  is  divided  by  a  line 
drawn  through  the  center  so  that  it  has  two  sides. 

There  is  no  logical  reason  for  this  selection  of  sides 
but  it  is  customary  to  enter  items  recording  liabilities  on 
the  right-hand  side  of  an  account  with  the  creditor,  and 
items  showing  that  a  person  has  become  a  debtor  on 
the  left-hand  side  of  his  account.     This  practice  has 


DOUBLE-ENTRY  BOOKKEEPING 


43 


Merchandise  (Goods) 


1919 
Jan. 


Brown  &  Sharpe 


$100 


00 


Brown  &  Sharpe 


1919 
Jan.     3 


Notes  Payable 


$100 


on 


1919 
Jan. 


Merchandise 


$100 


00 


Notes  Payable 


1919 
Jan. 

3 

Brown  &  Sharpe 


$100  00 


Form  1.  Ledger  Accounts  with  Postings 


44  FUNDAMENTAL  PRINCIPLES 

resulted  in  the  right-hand  side  of  an  account  being 
known  as  the  credit,  and  the  left-hand  as  the  debit 
side,  and  it  is  furthermore  customary  to  refer  to  the 
placing  or  posting  of  the  items  therein  as  debiting 
or  crediting  an  account.  This  same  method  of  debit- 
ing and  crediting  is  used  to  record  in  accounts  trans- 
actions other  than  those  with  individuals  (i.e.,  ac- 
counts with  cash,  merchandise,  and  the  like),  so  that 
throughout  the  bookkeeping  system  the  accounts  are 
kept  "in  equilibrium";  i.e.,  the  total  of  all  debit  entries 
should  always  equal  the  total  of  all  credit  entries  in  the 
ledger  and  in  this  way  the  clerical  accuracy  of  the 
posting  is  proved  in  part.  This  phase  of  the  work  will 
be  taken  up  later  (Chapter  VII),  where  methods  of 
testing  the  accuracy  of  the  ledger  postings  by  means  of 
a  "trial  balance"  are  described. 

7.    The  Balance  of  an  Account 

When  one  side  of  an  account  exceeds  the  other,  i.e., 
when  the  credits  are  greater  than  the  debits  or  vice 
versa,  the  account  is  said  to  have  a  balance.  The  balance 
of  an  account  may  be  denned  as  the  excess  of  one  side 
over  the  other,  and  it  is  given  the  name  of  the  side  on 
which  the  excess  is  found.  For  example,  if  the  debits 
exceed  the  credits,  an  account  is  said  to  have  a  debit 
balance. 

Each  side  of  the  ledger  account  is  usually  added  at 
the  end  of  each  month  or  oftener  if  desired;  and  where 
the  total  is  not  readily  apparent  it  should  be  entered 
in  pencil  in  small  figures  immediately  under  the  last 
regular  entry,  which,  of  course,  is  in  ink.  The  balance 
of  the  account  should  generally  be  noted  in  pencil  in  the 


DOUBLE-ENTRY  BOOKKEEPING  45 

explanation  space  on  the  side  of  the  account  on  which 
it  occurs. 


REVIEW  QUESTIONS 

1.  What  is  a  business  transaction? 

2.  Illustrate  the  "  twofold  effect "  of  a  business  transaction  by : 

(a)  The  sale  of  a  horse  for  $100. 

(b)  The  purchase  of  a  pound  of  butter  for  50  cents. 

(c)  The  hiring  of  the  services  of  a  window-cleaner  for  $2. 

3.  (a)  What  is  an  account? 
(b)  What  is  a  ledger? 

4.  Describe  the  form  of  an  account. 

5.  How  is  the  balance  of  an  account  determined? 

6.  A  piece  of  real  estate  was  bought  on  May  15,  1918,  for  $30,000. 

Investigation  of  title  costs  amounted  to  $900;  sidewalks, 
curbing,  grading,  etc.,  cost  $700.  The  land  was  sold  one  year 
later  for  $60,000.    Make  up  the  account  for  the  land. 

7.  Paul  Masterson  owed  us  $1,000  on  July  1,  1919.     On  July  3, 

he  paid  us  $100  on  account;  on  August  1,  he  bought  goods 
amounting  to  $50 ;  on  August  3  he  returned  goods  to  us  as  un- 
satisfactory amounting  to  $15;  on  August  31,  he  settled  his 
account  in  full,  being  allowed  2%  discount.  Make  the  neces- 
sary entries  in  his  account. 


CHAPTER   V 

DETERMINATION  OF  CAPITAL  OR 
DEFICIT 

1.    Method  of  Ascertaining  Capital  or  Deficit 

As  explained  in  Chapter  III,  capital  is  the  excess  of 
assets  over  liabilities,  and  deficit  is  any  excess  of  liabili- 
ties over  assets.  It  is  evident,  therefore,  that  to  deter- 
mine the  capital  or  deficit  at  any  time,  it  is  first  neces- 
sary to  ascertain  the  amount  of  assets  and  liabilities. 
Any  excess  of  the  one  over  the  other  then  represents 
capital  or  deficit  as  the  case  may  be. 

Suppose  that  Charles  Warren  is  going  to  begin 
business  with  $14,500  in  cash  of  his  own,  and  $4,000  of 
borrowed  money,  for  which  he  has  given  his  note  to  his 
brother.  The  statement  of  assets  and  liabilities  would 
then  be  very  simple;  the  following  form,  although  not 
technical,  states  all  the  facts.  It  is  prepared  in  the 
"running"  or  statement  form,  which,  as  explained  later, 
is  frequently  used. 

STATEMENT  OF  ASSETS  AND   LIABILITIES 

December  81,  1918 

Assets,  Cash  in  Bank $18,500.00 

Liabilities,  Notes  Payable 4,000.00 

Charles  Warren's  Capital  (Net  Worth) $14,500.00 

46 


DETERMINING  CAPITAL  OR  DEFICIT  47 

This  statement  if  arranged  in  more  formal  account- 
ing shape  would  be  as  follows: 

CHARLES   WARREN 
STATEMENT    OF   ASSETS   AND    LIABILITIES 

As  of  December  31,  1918 


Assets 
Cash  in  Bank $18,500.00 


$18,500.00 


Liabilities 

Notes  Payable $  4,000.00 

Charles  Warren,  Capital.     14,500.00 


$18,500.00 


It  will  be  noticed  that  the  entry  of  the  proprietor's 
net  worth  on  the  right-hand  side  makes  the  statement 
balance.  The  capital  is  entered  on  the  right-hand  side 
as  if  a  liability.  It  is  not  legally  a  liability,  but  for 
accounting  purposes  it  is  treated  as  a  liability.  The 
business  is  accountable  to  the  proprietor  but  is  not 
legally  liable.  In  the  event  of  insolvency  all  the  legal 
liabilities  would  have  to  be  paid  before  the  proprietor 
would  have  any  claim  on  any  of  the  assets. 

2.    Statement  of  a  Going  Business 

If  Charles  Warren  continued  in  business,  he  would 
want  a  statement  showing  his  capital  or  net  worth  at 
the  end  of  every  quarter  or  six  months  or  year.  Assume 
that  at  the  end  of  six  months  the  business  had  assets 
and  liabilities  as  shown  in  the  following  schedule;  this 
schedule  being  only  an  informal  list  prepared  without 
regard  to  accounting  or  bookkeeping  form  and  there- 
fore not  showing  totals  or  the  computation  of  the 
present  capital. 


48  FUNDAMENTAL  PRINCIPLES 

Assets 

Cash    $  1,500.00 

Notes  Receivable : 

B.  Alton $1,000.00 

C-  D°dd 1,000.00  2,000.00 

Accounts  Receivable: 

A.  Henry $2,000.00 

C.  Traver 2,500.00 

K-  Dorr 3,000.00 

E.  Smith 500.00  8,000.00 

Merchandise 7,500.00 

Furniture  and  Fixtures 300.00 

Machinery  and  Tools 2  000.00 

Land  and  Buildings 12,000.00 

Liabilities 

Notes  Payable : 

Kerr  &  Co $  1,000.00 

Accounts  Payable: 

Kerr  &  Co $2,000.00 

A.  R.  Butler  and  Son 4,000.00 

Rover  &  Jones 3,000.00 

Sunset  Merchandising  Co 4,000.00  13,000.00 


By  listing  the  foregoing  assets  and  liabilities  in  a 
formal  statement  it  is  seen  that  Charles  Warren  has 
assets  to  the  amount  of  $33,300,  of  which  amount 
$14,000  is  owing  by  the  business  to  various  creditors. 
The  excess  of  assets  over  liabilities,  $19,300,  represents 
the  capital  at  that  time  in  the  business.  Such  state- 
ment is  given  below: 


DETERMINING  CAPITAL  OR  DEFICIT 
CHARLES   WARREN 

STATEMENT  OF  ASSETS  AND  LIABILITIES 

As  of  June  30,   1919 


49 


Assets 

Cash $  1,500.00 

Notes  Receivable 2,000.00 

Accounts  Receivable 8,000.00 

Merchandise  Inventory...  7,500.00 

Furniture  &  Fixtures 300.00 

Machinery  &  Tools 2,000.00 

Land  &  Buildings 12,000.00 

$33,300.00 


Liabilities 

Notes  Payable $  1,000.00 

Accounts  Payable 13,000.00 

Total $14,000.00 

Charles  Warren,  Capital.  19,300.00 


$33,300.00 


This  statement  is  brought  into  balance  by  the 
insertion  of  Charles  Warren's  capital  on  the  right-hand 
side.  It  would  similarly  be  brought  into  balance  by  the 
insertion  of  "Deficit,"  if  there  were  one,  on  the  left- 
hand  side.  Bringing  the  statement  to  a  balance  in  this 
way  is  known  as  "establishing  its  equilibrium,"  and  in 
connection  with  double-entry  bookkeeping  the  state- 
ment itself  is  known  as  a  "balance  sheet." 

3.    Recording  Subsequent  Facts  in  Accounts 

Financial  condition  changes  constantly  as  business 
operations  take  place.  It  would  be  possible  to  show 
the  altered  condition  at  the  close  of  each  day  by  making 
a  new  statement  or  by  changing  the  figures  in  the  first 
statement.  For  instance,  if  merchandise  of  $1,500  were 
purchased  on  credit,  the  asset  merchandise  shown  on  the 
statement  in  §  2  would  be  increased  from  $7,500  to 
$9,000,  and  the  accounts  payable  from  $13,000  to 
$14,500.      In   this   example   an   increase   in   assets   is 


50  FUNDAMENTAL  PRINCIPLES 

exactly  offset  by  an  increase  in  liabilities.  The  equi- 
librium has  not  been  disturbed.  If,  then,  a  customer 
paid  $500  on  his  account,  the  asset  cash  would  be 
changed  from  $1,500  to  $2,000,  an(j  the  accounts  receiv- 
able from  $8,000  to  $7,500.  In  this  second  case  we  have 
an  increase  in  one  asset  offset  by  a  corresponding  de- 
crease in  another  asset. 

It  is  obvious  that  when  business  transactions  are 
numerous,  to  keep  track  of  these  fluctuations  by  making 
continuous  daily  changes  in  the  balance  sheet  would  be 
utterly  impossible.  Therefore,  accounts  are  opened  in 
the  ledger  for  each  kind  of  asset  and  liability  and  for 
the  capital  of  the  proprietor.  The  equilibrium  estab- 
lished in  the  opening  statement  is  preserved  in  the  ledger 
accounts  by  entering  each  item  on  the  same  side  of  its 
appropriate  account  as  that  on  which  it  appears  in  the 
statement.  Thus  amounts  representing  assets  are  en- 
tered on  the  left  side  of  the  proper  accounts,  and  those 
representing  liabilities  and  accountability  for  capital  on 
the  right  side.  If  this  procedure  is  followed  it  is  clear 
that  the  total  debits  in  all  the  accounts  must  equal  the 
total  credits  and  the  accounts  will  be  nothing  more  than 
a  transcript  of  the  financial  statement. 

Subsequent  transactions  can  easily  be  recorded  in 
the  accounts  by  debiting  or  crediting  them,  as  transac- 
tions take  place,  according  to  the  procedure  to  be  ex- 
plained in  following  chapters,  and  in  this  way  the 
equilibrium  established  in  the  beginning  is  preserved. 

4.    Recording  Subsequent  Facts  Showing  Profit  or  Loss 

Thus  far,  accounts  relating  only  to  assets  and  liabili- 
ties have  been  discussed.     We  have  now  to  consider 


DETERMINING  CAPITAL  OR  DEFICIT  51 

accounts  relating  to  expense  and  income,  the  nature  of 
which  is  indicated  by  their  name.  Assume  that  an  ex- 
pense, such  as  rent,  amounting  to  $300,  is  paid  in  cash. 
In  this  case  there  is  a  decrease  in  the  asset  of  cash  from 
$2,000  to  $1,700,  and  a  corresponding  decrease  in  capi- 
tal from  $19,300  to  $19,000.  As  a  second  example,  sup- 
pose that  merchandise  is  sold  for  $2,000,  which  is  $500 
more  than  was  paid  for  it.  Here  there  is  a  decrease  of 
$1,500  in  the  Merchandise  account,  offset  by  an 
increase  of  $1,500  in  the  Cash  account.  In  addition 
we  have  still  $500  in  cash  received  which  must  be  ac- 
counted for.  Therefore,  Cash  account  is  increased  $500 
as  the  result  of  a  profit  and  there  is  a  corresponding 
increase  of  $500  in  our  capital. 

Obviously  when  transactions  which  affect  capital 
frequently  occur,  it  is  a  cumbersome  procedure  to  pass 
every  fluctuation  through  the  Capital  account  on  the 
ledger. 

5.    The  Use  of  Income  and  Expense  Accounts 

The  difficulty  is  solved  by  the  use  of  income  and 
expense  accounts.  For  example,  if  the  business  re- 
ceived a  payment  of  interest  the  transaction  would  be 
recorded : 

Cash    $30.00 

Interest $30.00 

Interest,  an  income  account  in  the  ledger,  would  be 
credited  with  the  amount  received. 

If,  instead,  cash  was  paid  for  salaries,  the  entry 
would  involve  the  Cash  account  and  an  expense  account 
and  would  be  as  follows: 


52  FUNDAMENTAL  PRINCIPLES 

Salaries $40.00 

Cash    $40.00 

Salaries,  an  expense  account  in  the  ledger,  would 
be  debited  with  the  amount  paid  out. 

6.    The  Use  of  the  Profit  and  Loss  Account 

At  the  end  of  some  period,  as  a  month,  a  half-year, 
or  year,  all  of  the  income  and  all  of  the  expense  ac- 
counts are  balanced  and  these  balances  are  trans- 
ferred to  a  ledger  account  called  "Profit  and  Loss." 
The  balances  showing  income  are  transferred  to  the 
credit  side  of  the  Profit  and  Loss  account.  The 
balances  showing  expenses  are  transferred  to  the  debit 
side  of  the  Profit  and  Loss  account.  If  the  balance  of 
the  Profit  and  Loss  account  is  on  the  credit  side,  the 
business  is  paying  and  capital  has  been  increased  by  the 
amount  of  the  balance.  This  balance  is  then  transferred 
to  the  credit  side  of  the  ledger  account  with  capital.  An 
example  of  a  Profit  and  Loss  account  is  given  in  Chap- 
ter VIII,  where  the  subject  is  taken  up  in  greater 
detail. 


REVIEW  QUESTIONS 

1.  Illustrate  how  one  would  determine  a  proprietor's  capital  when 

he  begins  a  business  with  an  investment  of  at  least  four  pri- 
vate assets  and  with  at  least  two  liabilities. 

2.  Define  "deficit." 

3.  (a)   What  is  meant  by  the  "principle  of  equilibrium"? 

(b)   How  is  the  equilibrium  of  the  ledger  accounts  maintained? 

4.  (a)   Why  could  not  a  balance  sheet  statement  be  kept  in  balance 

by  noting  on  it  the  changes   caused  by  each  business 
transaction? 


DETERMINING  CAPITAL  OR  DEFICIT  53 

(b)   How  are  these  changes  grouped  and  finally  brought  on  the 
balance  sheet? 

5.  (a)  What    kind    of    account    would    salaries    paid    be    passed 

through  ? 
(b)  What  kind  of  an  account  would  interest  received  be  en- 
tered in? 

6.  (a)   What  is  the  account  in  which  all  items  of  income  and  ex- 

pense are  finally  marshalled? 
(b)   In  such  an  account  on  which  side  would  losses  be  entered? 


Part  II 
The  Ledger 


CHAPTER   VI 
CLASSIFICATION  OF  LEDGER  ACCOUNTS 

1.  Importance  of  Correct  Classification 

Any  science  is  a  science  only  so  far  as  it  classifies 
and  groups  the  facts  on  which  it  is  based  according  to 
their  resemblances.  Unless  this  grouping  is  done  in- 
telligently and  is  founded  on  real  resemblances  and  real 
differences,  the  facts  will  fail  to  state  the  full  truth,  the 
conclusions  drawn  therefrom  may  prove  erroneous,  and 
the  science  will  not  fulfill  its  purpose  of  imparting 
knowledge  which  is  true  and  admits  of  no  controversy. 
Accordingly,  an  accounting  system  is  of  value  only  to 
the  extent  that  it  successfully  reveals  the  true  trend  of 
business  activity,  gathering  up  the  facts  as  they  occur 
day  by  day  and  recording  results  and  effects  in  terms 
of  figures.  Therefore,  for  the  system  to  do  this,  busi- 
ness transactions  must  first  be  classified  under  headings 
which  correctly  indicate  their  nature,  and  the  accounts 
in  their  turn  must  be  grouped  in  the  same  way.  Incor- 
rectness and  indefiniteness  in  terminology  create  con- 
fusion, lead  to  error  in  the  recording  of  facts  and  will 
cause  the  most  elaborate  system  to  break  down. 

2.  Object  of  Classification 

The  classification  of  accounts  is  determined  by  the 
kind  of  information  required  on  the  statements  compiled 
at  the  end  of  a  fiscal  period.  The  balance  sheet,  as  we 
have  seen,  is  a  condensed  list  of  assets  and  liabilities, 

57 


58  THE  LEDGER 

and  the  difference  between  the  two  constitutes  the 
capital  or  deficit  of  the  business,  as  the  case  may  be. 
The  profit  and  loss  statement  presents  a  summary 
of  the  balances  of  accounts  relating  to  income  and 
expense,  and  the  difference  between  the  two  constitutes 
either  a  profit  or  a  loss.  Therefore,  every  account  kept 
on  the  general  ledger  can  be  classified  primarily  under 
one  of  the  five  heads  enumerated  below : 


General 

rl. 
2. 
3. 

Assets 

Liabilities 

Capital 

Balance  Sheet 
Accounts 

Ledger 

J 

4. 
^5. 

Income 
Expense 

I  Profit  and  Loss  Accounts 

To  label  an  account  as  belonging  to  one  of  the  five 
heads  listed  above  does  not,  however,  go  far  enough. 
There  are  numerous  varieties  of  assets,  many  kinds  of 
liabilities,  various  sources  of  income,  and  as  for  the 
items  of  expense,  these  alone  may  run  into  a  formidable 
list  the  length  of  which  will  depend  upon  the  size  and 
ramifications  of  the  business  and  the  minuteness  with 
which  expenses  are  analyzed  and  classified.  The  under- 
lying idea  of  account-keeping  is  to  collect  and  classify 
like  transactions  as  they  occur,  thus  losing  sight  of  the 
detail  and  building  up  a  summary  which  presents  in  con- 
densed form  the  result  of  the  transactions  during  a  given 
period. 

3.     Real  and  Personal  Accounts 

The  balance  sheet  accounts  are  known  also  as  real 
or  personal  accounts,  the  latter  representing  all  relation- 


CLASSIFICATION  OF  LEDGER  ACCOUNTS  59 

ships  with  persons  (debtors,  creditors,  or  proprietors) 
and  the  former  covering  all  assets  except  claims  against 
persons.  Logically,  all  balance  sheet  accounts  are  real 
accounts  because  they  represent  real  things,  tangible  or 
intangible,  which  actually  exist,  i.e.,  assets,  liabilities, 
and  the  accountability  to  the  proprietor.  For  conve- 
nience, however,  accounts  with  persons,  e.g.,  accounts  re- 
ceivable, accounts  payable,  and  capital  accounts,  are  fur- 
ther classified  as  personal  accounts.  They  differ  from 
real  accounts  only  in  that  they  concern  persons.  Reflec- 
tion will  show  that  every  liability  account  is  personal  be- 
cause it  shows  the  relation  with  a  creditor.  Capital  ac- 
count is  personal  because  it  represents  the  accountability 
of  the  business  to  a  person  known  as  the  proprietor. 
Notes  receivable  and  notes  payable  are  personal  ac- 
counts, the  only  difference  between  them  and  accounts 
receivable  and  payable  being  in  the  form  or  evidence  of 
the  obligation. 

4.      Nominal  Accounts 

The  profit  and  loss  accounts  are  called  "nominal" 
because  they  are  accounts  in  name  only.  They  are  not 
real  accounts  because  they  do  not  represent  real  things 
having  present  existence  like  assets,  liabilities,  and  the 
accountability  to  the  proprietor.  Instead,  they  repre- 
sent increases  or  decreases  in  capital  resulting  from  in- 
come or  expense.  Such  increases  or  decreases  could 
logically  be  credited  or  debited  directly  to  the  capital 
account  but  that  would  not  be  convenient  bookkeeping 
because  it  would  unduly  complicate  the  capital  account 
and  would  not  accumulate  information  concerning  in- 
come and  expense  items  in  statistical  form.    Therefore, 


60  THE  LEDGER 

temporary  accounts  are  opened  for  them.  At  the  end 
of  the  fiscal  or  accounting  period,  these  nominal  ac- 
counts are  closed  into  the  capital  account  (through  a 
profit  and  loss  account  as  noted  in  Chapter  V) .  In  the 
meantime  these  accounts  are  in  effect  suspended  debits 
or  credits  properly  belonging  in  the  capital  account. 
They  are  in  the  form  of  accounts,  but  they  are  accounts 
in  name  only  and  thus  are  called  nominal. 

5.     Extension  of  Classification  of  Accounts 

From  this  it  follows  that  if  statements  presented 
at  the  end  of  a  period  are  to  show  the  results  of 
operations  during  the  period,  the  original  analysis 
and  record  of  transactions  must  be  made  with  great 
care.  Therefore,  as  an  aid  to  this  analysis  and  the  cor- 
rect classification  of  transactions  in  the  first  instance, 
the  five  kinds  of  accounts  listed  in  §  2  are  further  sub- 
divided into  certain  fundamental  groups,  the  nature  of 
which  is  to  some  extent  indicated  by  their  titles  shown 
below: 

1.  Asset  Accounts 

Fixed  or  Permanent 
Current  or  Floating 
Deferred  Expense 

2.  Liability  Accounts 

Fixed  or  Permanent 
Current  or  Floating 
Deferred  Income 

3.  Capital  Accounts 

Proprietors,  Personal 
Proprietors,  Capital 


CLASSIFICATION  OF  LEDGER  ACCOUNTS  61 

4.  Income  Accounts 

Sales 

Income    from    Investments    or    Securities 

Owned 
Miscellaneous  Income 

5.  Expense  Accounts 

Manufacturing  Cost 

Selling  Expenses 

General  Administrative  Expenses 

6.     Further  Subdivision  of  Groups  of  Accounts 

The  accounts  of  every  mercantile  or  manufacturing 
business  may  be  classified  under  the  above  groupings 
or  headings  which  indicate  broadly  the  purpose  for 
which  a  particular  account  is  opened  and  the  effect  of 
its  balance  upon  the  statement  of  financial  condition. 
Each  of  these  groups  may  be  further  subdivided  into  as 
many  accounts  as  are  needed  to  classify  the  various 
kinds  of  transactions  which  fall  under  different  heads 
within  the  group.  Thus,  the  group  of  permanent  or 
fixed  assets  may  consist  of  accounts  kept  with  land, 
buildings,  machinery,  furniture  and  fixtures,  delivery 
equipment,  office  equipment,  good-will,  and  any  other 
asset  which  is  carried  on  the  books  at  a  valuation  fixed 
or  determined  by  its  cost  to  the  business  and  not  by  the 
amount  realizable  at  an  enforced  sale. 

At  this  stage  of  the  discussion  nothing  is  to  be 
gained  by  appending  a  complete  list  of  the  accounts 
most  commonly  opened  under  the  above  groupings,  and 
the  reader  is  referred  for  such  a  list  to  Chapters 
XXXVI  and  XXXVII.  The  point  for  the  student  to 
note  is  that  if  the  function  of  a  group  to  which  a  particu- 


62  THE  LEDGER 

lar  account  belongs  and  the  effect  of  this  group  on  the 
balance  sheet  or  profit  and  loss  are  thoroughly  under- 
stood; and  if  furthermore  an  adequate  number  of  ac- 
counts are  opened  and  so  grouped  and  entitled  on  the 
ledger  that  the  classification  of  transactions  can  be 
readily  and  correctly  made,  then  the  recording  of  entries 
in  their  proper  accounts  is  simplified  and  the  correct 
debiting  and  crediting  of  the  amounts  involved  is 
assured. 

7.     Classification  as  an  Aid  to  Correct  Bookkeeping 

The  reason  for  this  can  be  made  clear  by  means  of 
an  illustration.  Assume  that  on  the  opening  of  a  busi- 
ness an  invoice  is  received  for  several  filing  cabinets,  a 
supply  of  filing  cards  and  folders  and  some  office 
stationery.  The  fixed  assets  of  a  business  represent  an 
investment  of  money  in  something  of  permanent  value 
to,  or  of  more  or  less  permanent  use  in,  the  business.  As 
the  filing  cabinets  obviously  belong  to  this  category,  an 
asset  account  entitled  "Office  Furniture  and  Fixtures" 
is  opened  in  the  section  of  the  ledger  devoted  to  the 
group  of  fixed  asset  accounts  and  debited  with  the  price 
of  the  cabinets.  Asset  accounts,  as  we  have  seen,  nor- 
mally have  debit  balances.  Therefore  it  is  easy  to  re- 
member that  the  purchase  of  an  asset  is  recorded  by 
debiting  the  account  describing  the  thing  purchased. 

The  invoice  also  covers  the  purchase  of  other  articles 
which  will  not  be  permanently  used  in  the  business. 
Assuming  that  a  year's  supply  of  filing  cards  and 
folders  has  been  bought  and  that  the  office  stationery 
is  for  current  consumption,  to  be  taken  into  use  at  once, 
then  it  is  apparent  that  the  cost  of  the  cards  and 


CLASSIFICATION  OF  LEDGER  ACCOUNTS         63 

folders  should  be  deferred  and  spread  over  the  year's 
operations,  while  the  stationery  represents  an  expendi- 
ture for  the  immediate  needs  of  the  business,  i.e.,  an 
expense.  A  purchase  the  cost  of  which  is  to  be  deferred 
and  charged  gradually  to  future  operations  is  none  the 
less  an  asset  though  an  asset  of  rapidly  diminishing 
value  while  the  supply  lasts.  Therefore  it  is  debited 
to  some  suitable  asset  account  such  as  Office  Supplies, 
which  is  opened  in  the  section  of  the  ledger  devoted  to 
accounts  in  which  such  deferred  charges  are  entered. 
The  mere  opening  of  an  account  in  this  part  of  the 
ledger  indicates  that  at  the  close  of  the  fiscal  period 
part  of  the  asset  value  shown  therein  should  be  charged 
to  current  operations,  as  an  expense  or  diminution  of 
profit.  The  method  of  doing  this  will  be  discussed  later 
when  the  Profit  and  Loss  account  is  considered. 

The  stationery,  as  we  have  seen,  is  for  current  needs 
and  constitutes  one  of  the  expenses  of  carrying  on  or 
administering  the  business.  Therefore,  an  account 
headed  "Office  Stationery"  or  other  suitable  title,  is 
opened  in  the  general  administrative  expense  section  of 
the  ledger.  As  all  expense  accounts,  for  reasons  pre- 
viously explained,  normally  have  debit  balances,  no 
mistake  can  be  made  as  to  the  side  of  the  account  on 
which  the  expense  item  should  appear;  while  the  in- 
clusion of  the  account  in  the  expense  section  of  the 
ledger  indicates  that  its  balance  is  to  be  closed  out  at 
the  end  of  the  period  to  the  debit  of  Profit  and  Loss 
account.  This  procedure  will  be  described  in  later 
chapters.  Here  it  is  sufficient  to  draw  attention  to  the 
advantages  of  so  grouping  accounts  that  the  nature  of 
the  entries  in  each  case  (whether  a  debit  or  credit)  is 


64  THE  LEDGER 

thereby  indicated  as  well  as  the  disposition  of  the 
amounts  shown  therein  at  the  close  of  the  fiscal  period. 

8.  Making  Offsetting  Entries 

The  credit  entry  or  entries  to  offset  the  three  sup- 
posititious debits  just  discussed  need  only  brief  com- 
ment. Each  purchase  transaction  creates  a  current  or 
floating  liability.     The  liability  may  be  extinguished 

(1)  by  a  prompt  cash  payment,  crediting  Cash,  or 

(2)  it  may  be  entered  on  the  books  by  crediting  the 
person  from  whom  the  purchase  is  made  if  on  account, 
or  (3)  Notes  Payable  account  may  be  credited  if  a  note 
is  given  in  payment.  Creditor's  account  and  Notes  Pay- 
able account  are  kept  in  the  section  of  the  ledger  de- 
voted to  the  classification  of  current  liability  accounts. 
As  a  liability  account  must  have  a  credit  balance,  an 
entry  in  this  section  of  the  ledger  is  either  credited  to 
show  an  increase  of  liability  or  debited  to  record  a  pay- 
ment when  a  liability  is  extinguished. 

9.  Classification  an  Aid  to  Preparation  of  Statements 

In  addition  to  simplifying  the  work  of  bookkeeping 
and  insuring  the  correctness  of  the  records  in  the  ways 
explained,  the  classification  of  accounts  also  facilitates 
the  preparation  of  financial  statements  at  the  close  of 
a  fiscal  period.  If,  for  example,  all  expense  accounts 
are  grouped  in  one  section  of  the  ledger  and  income 
accounts  in  another,  the  account  balances  shown  in  each 
section  furnish  the  data  for  compiling  the  profit  and 
loss  statement.  As  asset  and  liability  accounts  are 
grouped  under  suitable  headings,  the  sum  of  all  the 
balances  of  the  accounts  within  a  group  constitutes  the 


CLASSIFICATION  OF  LEDGER  ACCOUNTS         65 

figures  which  appear  under  that  head  on  the  balance 
sheet.  The  method  of  grouping  and  classifying  ac- 
counts on  the  ledger  should  be  such  as  to  facilitate  the 
presentation  of  the  data  summarized  on  the  balance 
sheet. 

10.     Asset  Accounts 

Fixed  assets,  it  may  here  be  repeated,  are  those 
which  are  permanent  in  nature  and  with  which  the  busi- 
ness is  carried  on.  Thus,  an  account  may  be  opened 
within  the  group  of  fixed  assets  for  tangible  things  such 
as  buildings,  machinery,  patterns,  etc.,  or  intangible 
things  such  as  patent  rights,  leaseholds,  good- will,  etc., 
providing  the  thing  specified  in  the  account  heading  is 
of  more  or  less  permanent  value  to  the  business. 

Current  assets,  known  also  as  "floating"  and  "quick" 
assets,  consist  of  cash  and  those  assets  which  in  the  or- 
dinary course  of  business  will  be  converted  into  cash. 
Attention  is  invited  to  the  use  of  the  word  "will."  The 
test  of  a  current  asset  is  not  whether  it  can  be  converted 
into  cash,  more  or  less  quickly,  but  whether  it  will  be  so 
converted  in  the  ordinary  course  of  business.  Examples 
of  current  assets  are  cash,  accounts  and  notes  receivable, 
and  merchandise. 

"Deferred  Expense"  is  a  general  term  which  covers 
any  expense  or  service  paid  for  but  not  imme- 
diately absorbed  by  the  operations  of  the  business; 
e.  g.,  insurance  premiums  paid  in  advance,  adver- 
tising paid  in  advance  or  advertising  supplies  not  ex- 
hausted, office  or  stable,  or  storeroom,  or  fuel  supplies 
not  exhausted,  and  so  on.  Such  services  paid  for  or 
supplies  on  hand  are  just  as  much  an  asset  to  the  busi- 


66  THE  LEDGER 

ness  until  exhausted  as  is  a  piece  of  machinery  until  it 
is  worn  out,  or  a  patent  right  until  it  expires.  While 
such  assets  as  these  are  as  a  rule  of  small  value  in  com- 
parison with  the  fixed  and  current  assets,  their  inclusion 
on  the  balance  sheet  is  essential  for  the  correct  showing 
of  financial  conditions. 

For  the  proper  debiting  and  crediting  of  the  numer- 
ous accounts  within  this  group  see  Chapters  XXXVI 
and  XXXVII. 

11.     Liability  Accounts 

Fixed  liabilities  represent  obligations  to  pay  cer- 
tain sums  at  future  fixed  dates,  the  terms  of  payment 
being  as  a  rule  legally  stated  by  a  mortgage  bond,  a 
debenture  bond,  or  any  other  formal  instrument. 

Current  or  "floating"  liabilities  include  all  liabilities 
except  those  classed  as  fixed;  e.g.,  accounts  payable, 
notes  payable,  taxes  due  but  not  yet  paid  (accrued 
taxes),  accrued  interest  on  mortgages  or  on  bonds,  etc. 
The  practical  distinction  between  fixed  and  current  lia- 
bilities is  usually  the  length  of  time  the  obligation  has  to 
run.  Liabilities  maturing  within  one  year  are  commonly 
called  current. 

Deferred  income  represents  the  obligation  to  render 
service  or  deliver  an  asset  at  some  future  time  for  which 
the  consideration  has  already  been  received.  Rent  may 
have  been  received  for  a  given  period  whiqh  extends  be- 
yond the  end  of  the  present  fiscal  period.  To  classify 
such  an  item  in  an  income  belonging  to  the  profit  and 
loss  section  of  the  ledger  would  be  incorrect  because  only 
part  of  the  rent  represents  a  profit  of  the  current  period. 
The  balance  must  be  carried  on  the  books  as  deferred 


CLASSIFICATION  OF  LEDGER  ACCOUNTS  67 

income  until  the  period  covered  by  the  rent  has  expired. 
A  cardinal  principle  of  sound  accounting,  as  will  be  seen 
later,  is  that  no  profit  shall  be  shown  on  the  books  unless 
earned.  Deferred  income  items  are  outside  the  regular 
routine  of  ordinary  mercantile  business.  When  they 
exist,  however,  they  should  be  indicated  on  the  balance 
sheet  and  on  the  books. 

The  debits  and  credits  to  the  accounts  commonly 
found  in  the  liability  group  are  shown  in  Chapters 
XXXVI  and  XXXVII. 

12.  Capital  Accounts 

The  operation  of  this  group  of  accounts  will  be  more 
clearly  understood  as  the  subject  is  developed  in  later 
chapters.  For  the  present  all  that  is  necessary  is  to 
state  that  the  primary  function  of  the  capital  ac- 
counts in  all  three  types  of  business  is  to  show  the 
excess  of  assets  over  liabilities  and  to  whom  the  business 
is  accountable  for  this  excess.  The  various  accounts 
which  usually  appear  in  the  capital  section  of  the  ledger 
with  the  usual  debits  and  credits  in  each  case  are  shown 
in  the  chapters  at  the  end  of  this  volume. 

13.  Income  Accounts 

Among  the  groups  of  accounts  which  record  income, 
much  the  most  important  is  the  Sales  account.  The 
main  source  of  income  in  every  business  is  the  sale  of 
something,  whether  this  be  goods  manufactured,  mer- 
chandise bought  for  resale,  or  a  service  of  some  kind. 
Sales  may  be  recorded  in  a  number  of  accounts,  depend- 
ing upon  how  sales  are  classified — by  lines,  territories, 
departments,  salesmen,  etc.    Other  sources  of  revenue, 


68  THE  LEDGER 

as  for  instance  from  investments,  royalties,  etc.,  fall 
within  the  income  group,  if  such  income  is  clearly  a 
profit  due  to  the  operations  of  the  business  during  the 
present  fiscal  period.  Otherwise  the  revenue  must  be 
included  in  the  deferred  income  class  and  only  that 
portion  of  it  which  is  applicable  to  the  present  period 
transferred  to  Profit  and  Loss  account  at  the  close  of 
this  period.  This  procedure  will  be  explained  and  illus- 
trated later.  For  the  present  all  that  need  be  borne 
in  mind  is  that  the  record  of  the  receipt  of  income  is 
invariably  made  to  the  credit  of  some  suitable  income 
account.  The  usual  income  accounts  opened  and  their 
debit  and  credit  entries  are  given  in  the  closing  chapters 
of  this  book. 

14.     Expense  Accounts 

The  accounts  within  this  group  are  usually  more 
numerous  than  those  under  any  other  head.  The  cost 
accounts  of  a  manufacturing  concern  are  in  themselves 
capable  of  being  recorded  in  almost  endless  detail  and 
variety.  As,  however,  these  constitute  a  separate  branch 
of  accounting  with  a  field  peculiarly  their  own,  the  sub- 
ject is  separately  covered  in  Volume  III  and  nothing 
further  is  here  required  than  to  note  their  existence.  The 
expense  accounts  of  a  mercantile  business  can  usually 
be  subdivided  under  the  heads  of  "Selling"  and  "Ad- 
ministrative." 

Selling  expense  includes  such  items  as  advertising, 
agents'  commissions,  salesmen's  salaries  and  commis- 
sions, expenses  of  shipping  and  credit  departments, 
sample  cases,  freight  outward,  clerical  help  exclusively 
employed  in  sales  department,  etc. 


CLASSIFICATION  OF  LEDGER  ACCOUNTS         69 

Administrative  expense  comprises  all  expense  con- 
nected with  the  operation  of  a  mercantile  business  other 
than  that  classified  as  selling  expense.  Examples  of  this 
class  of  expense  are  officers'  salaries,  directors'  fees, 
office  supplies,  postage,  telephone,  taxes,  legal  expenses, 
depreciation,  and  all  other  expenditures  made  for  the 
general  conduct  of  the  business. 

All  such  expenditures  are  invariably  debits  to  some 
suitable  expense  account,  the  debit  balance  of  which  in 
the  case  of  mercantile  accounts  is  closed  out  to  Profit 
and  Loss  account  at  the  end  of  the  fiscal  period.  This 
procedure  is  explained  in  Chapter  VIII;  and  the 
expense  accounts  most  commonly  opened  by  a  trading 
concern,  with  illustrations  of  their  debits  and  credits,  are 
shown  in  Chapters  XXXVI  and  XXXVII.  The  study 
of  those  chapters  in  connection  with  the  descriptive  defi- 
nitions given  in  this  chapter  will  help  to  fix  clearly  in 
mind  the  groups  or  classifications  under  which  all  ac- 
counts fall  and  the  proper  disposition  of  transactions 
within  them. 


REVIEW   QUESTIONS 

1.  What  is  the  purpose  of  classifying  accounts? 

2.  How  may  the  accounts,  kept  in  the  ledger  be  classified?    Define 

each  class. 
8.    Classify  the  following  accounts: 
Insurance 
Wages 
Investments 
Mortgage  Payable 
H.  Osborn,  Proprietor 
Returned  Purchases 
Taxes 


70  THE  LEDGER 

Returned  Sales 
Patents 
Tools 

Real  Estate 
Bills  Receivable 
Revenue 
4.  Would  you  consider  it  proper  to  include  as  an  asset  the  following 
items  ?    Why  ? 

Insurance  premium  unearned 

Taxes  paid  in  advance 

Advertising  expenses 


CHAPTER   VII 
THE  TRIAL  BALANCE 

1.  Introductory 

We  have  seen  that  when  books  are  kept  on  the 
double-entry  system  each  transaction  requires  debits  and 
credits  of  equal  amount,  although  not  always  equal  in 
the  number  of  items.  An  entry  may  have  several  debits 
for  one  credit  or  vice  versa ;  but  the  total  amount  debited 
must  equal  the  total  credited  to  all  accounts  affected. 
Consequently,  the  sum  of  the  debits  must  equal  the  sum 
of  the  credits  in  the  ledger.  A  quick  means  of  ascer- 
taining whether  or  not  this  condition  of  exact  balance 
exists  is  necessary  as  a  first  check  or  verification  of  any 
bookkeeping  work.  The  expedient  known  as  a  trial 
balance  provides  this  check. 

2.  Methods  of  Preparation 

A  trial  balance,  as  its  name  implies,  is  a  test  or  trial 
of  a  double-entry  ledger  to  see  whether  or  not  the  credits 
equal  the  debits ;  if  they  do,  the  ledger  is  said  to  be  "in 
balance."  This  is  not,  however,  conclusive  evidence  that 
the  accounts  are  correct.    (See  §  5.) 

There  are  two  common  ways  of  taking  or  preparing 
a  trial  balance.  One  is  to  list  the  total  debits  and  the 
total  credits  of  each  account,  and  the  other  is  to  list  only 
the  balance  of  each  account.  Under  both  methods  the 
amounts  shown  for  the  various  accounts  are  separated 
as  to  debits  and  credits,  and  the  total  of  the  debits  is 

71 


72  THE  LEDGER 

compared  with  the  total  of  the  credits.  The  method  of 
listing  balances  only  is  the  more  common  practice;  but 
the  first  method  is  used  to  some  extent.  Whichever 
method  be  adopted,  if  the  total  credits  are  not  shown  to 
be  equal  to  the  total  debits,  the  ledger  is  said  to  be  "out 
of  balance."  The  amount  by  which  one  total  exceeds 
the  other  is  known  as  the  "difference" ;  and  the  mistake 
or  mistakes  causing  that  difference  should  at  once  be 
ascertained. 

3.  Avoiding  Needless  Repetitions 

A  trial  balance  should  be  taken  at  least  monthly — 
often  enough  to  make  the  detection  of  errors  compara- 
tively easy  and  yet  not  so  frequently  as  to  become 
unnecessarily  burdensome.  For  the  average  business  a 
monthly  trial  balance  is  sufficient.  The  trial  balance 
should  be  so  arranged  as  not  to  necessitate  the  rewrit- 
ing of  the  names  of  ledger  accounts  each  month.  Most 
accounts  continue  from  month  to  month  and  are  repre- 
sented in  more  than  one  trial  balance  throughout  a  year. 
For  example,  a  Furniture  and  Fixtures  account  nor- 
mally appears  in  the  trial  balance  each  month  although 
its  balance  may  not  vary  from  month  to  month. 

4.  Uses  of  the  Trial  Balance 

While  the  principal  use  of  a  trial  balance  is  to  deter- 
mine whether  or  not  the  ledger  is  in  balance,  it  has  a 
further  use  in  supplying  data  for  the  preparation  of 
statements.  Statements  are  generally  rendered  monthly 
and  the  trial  balance,  if  properly  arranged,  provides  a 
ready  means  for  securing  most  of  the  figures.  To  facili- 
tate this  work,  the  trial  balance  should  list  the  accounts 


THE  TRIAL  BALANCE  73 

in  the  order  in  which  they  are  to  appear  on  the  state- 
ment, and  the  figures  shown  by  the  trial  balance  should 
be  those  required  by  the  statement.  As  a  general  rule, 
statements  show  net  figures ;  but  the  form  of  statement 
may  require  total  figures — for  example,  the  total 
charges  and  credits  to  an  account  such  as  Freight.  If 
net  figures  only  are  needed,  the  trial  balance  should 
show  the  balances  of  the  accounts;  but  if  total  figures 
are  required  it  should  show  total  debits  and  total  credits 
in  such  accounts.  The  trial  balance  may  be  arranged 
so  that  it  can  be  added  in  sections  and  provide  sub- 
totals which  will  agree  with  those  shown  on  the  required 
statements. 

5.    Limitations  of  the  Trial  Balance 

The  trial  balance  establishes  one  fact  only,  and  that 
is  whether  or  not  the  debits  equal  the  credits  throughout 
the  ledger.  It  is  evident,  therefore,  that  there  may  be 
mistakes  in  the  ledger  which  the  trial  balance  cannot 
disclose.  These  may  be  either  mistakes  of  charging  or 
crediting  a  wrong  account ;  or  they  may  be  mistakes  of 
addition  or  other  calculation.  The  latter  mistakes  will 
be  disclosed  by  a  trial  balance  unless  they  are  of  such  a 
nature  that  errors  on  the  debit  side  exactly  offset  those 
on  the  credit — a  coincidence  known  as  a  "compensat- 
ing" error. 

Mistakes  of  charging  or  crediting  a  wrong  ac- 
count may  first  occur  in  a  book  of  original  entry.  For 
instance,  an  item  for  repairing  machinery  may  be 
charged  to  Machinery  account  instead  of  to  Repairs, 
with  the  result  that  the  assets  of  the  business  are  over- 
stated and  the  expenses  understated.     On  the  other 


74  THE  LEDGER 

hand,  the  book  of  original  entry  may  have  correctly  as- 
signed the  item  to  the  proper  account,  but  it  had  been 
posted  in  error  to  a  wrong  account. 

Other  examples  are  mistakes  in  addition  or  other 
calculations  in  books  of  original  entry,  or  in  post- 
ing, or  in  ledger  accounts,  or  in  the  trial  balance 
itself.  Such  mistakes  would  be  disclosed  by  the 
trial  balance  unless  they  were  exactly  compensating. 
Sometimes  these  mistakes  can  be  detected  by  a  mere  in- 
spection of  the  figures.  A  person  familiar  with  the 
business  and  its  accounts  might  detect  an  abnormally 
large  balance  in  one  of  them.  Generally,  however, 
mistakes  which  are  not  disclosed  by  the  trial  balance 
will  be  disclosed  only  by  an  audit  made  by  some  person 
within  the  business  organization  or  by  a  professional 
auditor.  The  fact  that  a  trial  balance  will  not  disclose 
all  mistakes,  some  of  which  may  be  vital,  makes  it  desir- 
able to  have  the  books  audited  by  some  person  other 
than  the  bookkeeper  in  charge. 

6.    Illustrative  Problem 

The  method  of  preparing  a  trial  balance  can  be 
illustrated  by  a  supposititious  case.  Assume  that  an  ex- 
amination of  the  ledger  of  Thomas  Malen  shows  the 
following  accounts  with  the  amounts  therein : 

Thomas  Malen — Capital 

"~j   1919 

J  Jan.  2 $10,075.00 

Cash 


1919                       I   1919 
Jan.  31 $25,000.00   Jan.  31 $12,000.00 


THE  TRIAL  BALANCE 
Merchandise  Purchases 


75 


1919 
Jan.  31. 


1919 
$20,000.00      Jan.  20. 


$200.00 


Merchandise  Sales 


1919 
Jan.  15. 


1919 
$100.00  I   Jan.  31. 


$15,000.00 


Expenses 


1919 

Jan.    2. 

7. 

8. 

16. 

20. 

28. 

31. 


$200.00 
300.00 
100.00 
50.00 
475.00 
200.00 
100.00 


Notes  Receivable 


1919 
Jan.  31. 


$3,000.00 


1919 
Jan.  15. 
31. 


$    500.00 
1,000.00 


Notes  Payable 


1919 
Jan.  15. 
31. 


$5,000.00 
6,000.00 


Furniture  and  Fixtures 


1919 
Jan.    2. 
10. 


$1,500.00 
200.00 


76 


THE  LEDGER 
E.  Strauss 


1919 
Jan.    2. 
15. 
24. 


$1,200.00 
6,000.00 
5,000.00 


1919 
Jan.  12. 
25. 
30. 


$1,200.00 
6,000.00 
3,000.00 


K.  Otter 


1919 
Jan.     7. 
9. 


$1,400.00 
300.00 


1919 
Jan.    8. 
12. 
20. 


$200.00 
800.00 
350.00 


A.  Bender 


1919 
Jan.  22. 


$2,000.00 


15)19 
Jan.  22. 
31. 


$1,500.00 
300.00 


H.  Carver 


1919 

Jan.  10. 

20. 

25. 

81. 


$3,000.00 
500.00 
700.00 
800.00 


1919 
Jan.    3. 
15. 


$3,000.00 
4,000.00 


1919 
Jan.  15. 


M.  Olson 


1919 
$1,950.00       Jan.  10. 


$1,950.00 


A.  Lett 


1919 
Jan.  31. 


I       1919 
$3,000.00       Jan.  15. 


$5,000.00 


The  simple  procedure  of  listing  the  balances  of  the 
foregoing  accounts  as  shown  below,  with  debit  balances 


THE  TRIAL  BALANCE 


77 


in  the  first  column  and  credit  balances  in  the  second 
column,  produces  the  trial  balance,  the  equality  of  the 
figures  proving  that  the  ledger  is  in  balance : 

THOMAS  MALEN 

TRIAL  BALANCE 

January  31,  1919 


Thomas  Malen — Capital 

Cash  

Merchandise  Purchases. 

Merchandise  Sales 

Expenses 

Notes  Receivable 

Notes  Payable 

Furniture  and  Fixtures. 

E.  Strauss 

K.  Otter 

A.  Bender 

H.  Carver 

A.  Lett 


$13,000 
19,800 


$39,975  00     $39,975  00 


REVIEW    QUESTIONS 

1.  (a)   Define  a  trial  balance. 

(b)   What  is  shown  by  a  trial  balance? 

2.  (a)     What  is  the  function  of  a  trial  balance? 
(b)   Do  you  consider  its  use  necessary? 

3.  How  may  the  accounts  in  a  trial  balance  be  best  arranged? 

4.  Prepare  a  trial  balance  from  the  following: 

Discounts  to  customers $        4,030.00 

Entertainment   of  customers 2,000.00 

Inventory  of  miscellaneous  equipment 81,900.00 

Merchandise  purchases    410,000.00 

Notes  receivable 3,050.00 


78  THE  LEDGER 

Accounts  receivable   250,000.00 

Insurance  on  equipment    1,150.00 

Insurance  premiums,  employers'  liability 4,000.00 

Taxes  on  personal  property 1,000.00 

Interest,  general   4,470.00 

Cash    45,000.00 

Labor    335,000.00 

Power 21,000.00 

Repairs  to  equipment 1,310.00 

Miscellaneous  expenses   3,010.00 

Office  pay-roll 18,000.00 

Merchandise  inventory,  first  of  year 75,000.00 

Merchandise  sales    1,048,500.00 

Allowances  to  customers 10,900.00 

Office  furniture  and  fixtures 5,700.00 

Salaries  of  officers   15,000.00 

Postage    2,000.00 

Telegrams  and  telephones   1,800.00 

Bank  charges  for  collecting  checks  and  drafts  700.00 

Stationery  and  printing 3,050.00 

Freight  on  purchases   23,000.00 

Freight  on  sales 10,000.00 

Cartage  and  express  inward 3,750.00 

Premiums  paid  for  bonding  office  employees  .  .  250.00 

Traveling  expense  of  salesmen 17,500.00 

Salesmen's  commissions  and  salaries 40,000.00 

Notes  payable   99,050.00 

Accounts  payable 43,000.00 

Proprietor's  capital   243,520.00 

Professional  advisor's  fees 1,500.00 

Cartage — Out   4,300.00 

Discounts  allowed  on  our  purchases 6,300.00 

Returned  sales  from  customers 41,000.00 

(The  trial  balance  footing  should  be  $1,440,370.) 


CHAPTER  VIII 
DETERMINATION  OF  PROFIT  OR  LOSS 

1.  Double-Entry  Profit  and  Loss 

The  distinctive  feature  of  double-entry  bookkeep- 
ing, apart  from  the  principle  of  equilibrium,  is  the 
analyzed  information  given  concerning  profits  and 
losses.  Double-entry  bookkeeping  is  designed  to  record 
transactions  in  such  a  way  that  each  kind  of  income  and 
each  kind  of  expense  is  represented  by  an  account.  It 
is  evident  that  the  final  profit  or  loss  can  be  determined 
by  comparing  the  total  of  all  expenses  with  the  total  of 
all  income.  An  excess  of  the  income  total  constitutes 
a  profit,  and  an  excess  of  the  expense  total  constitutes 
a  loss. 

2.  Adjusting  Entries 

The  balances  of  income  and  expense  accounts  are 
ultimately  transferred  to  the  Capital  account.  Before 
effecting  this  transfer,  one  must  know  which  accounts 
these  are  in  order  to  know  which  balances  to  transfer. 

At  the  end  of  any  fiscal  period  it  is  almost  certain 
that  some  accounts  will  be  mixed  in  nature  in  that  they 
are  partly  profit  and  loss  and  partly  balance  sheet.  A 
simple  example  of  such  an  account  is  that  of  insurance 
where  a  premium  is  paid  for  three  years.  In  such  a 
case,  at  the  end  of  the  first  year  the  balance  of  the  In- 
surance account  includes  not  only  the  insurance  expense 
for  the  year  just  passed,  which  is  the  nominal  element, 

79 


80  THE  LEDGER 

but  also  an  asset  element  consisting  of  the  portion  of 
the  premiums  prepaid  which  have  provided  insurance 
for  two  years  more. 

Every  account  should  be  scrutinized  at  the  end  of 
a  fiscal  period  to  ascertain  its  exact  nature.  If  it  is  a 
mixed  account,  adjusting  entries  should  be  made  to  re- 
duce it  to  a  simple  account,  either  balance  sheet  or  profit 
and  loss.  The  adjustment  is  most  easily  effected  by 
opening  a  new  account  to  which  part  of  the  balance  of 
the  mixed  account  can  be  transferred.  If  an  account 
is  mixed,  in  that  it  contains  a  balance  sheet  and  a  profit 
and  loss  element,  it  is  obvious  that  the  removal  of  one 
of  these  elements  reduces  the  account  to  its  simplest 
form  by  leaving  in  it  only  the  other  element. 

3.     Example  of  a  Mixed  Account 

The  best  example  of  a  mixed  account  is  one  with 
merchandise  wherein  both  purchases  and  sales  are  re- 
corded. In  such  an  account  the  first  entry  would 
obviously  relate  to  either  purchases  or  an  opening  in- 
ventory. At  that  point  the  account  is  a  balance  sheet 
account  because  it  represents  simply  an  asset.  When 
a  sale  is  credited  the  account  then  becomes  mixed  be- 
cause the  sale  not  only  reduces  the  asset  by  the  cost  of 
goods  sold,  but  it  also  records  the  gross  profit — that  is 
to  say,  the  excess  of  the  selling  price  over  the  cost  of 
what  was  sold.  The  account  is  therefore  mixed.  It 
represents  both  the  cost  of  the  goods  on  hand — because 
the  cost  of  goods  purchased  has  been  debited  to  it  and 
the  credits  for  sales  include  the  cost  of  goods  sold — 
and  also  the  gross  profit  on  sales. 

In  the  form  in  which  the  account  stands,  the  gross 


DETERMINATION  OF  PROFIT  OR  LOSS  81 

profit  cannot  be  determined  because  the  credits  for  sales 
do  not  indicate  separately  the  gross  profit  and  the  cost 
of  goods  sold.  It  then  becomes  necessary  to  adjust  this 
mixed  account  in  order  to  ascertain  how  much  of  it  is 
the  nominal  element  of  gross  profit. 

4.  Ascertaining  the  Gross  Profit  on  Merchandise 

In  ordinary  accounting  practice  the  gross  profit  is 
determined  in  the  following  way:  First,  ascertain  the 
cost  of  the  goods  sold.  This  can  be  found  by  taking  an 
inventory  of  the  goods  on  hand  and  subtracting  it  from 
the  total  merchandise  on  hand  at  the  beginning  and 
purchased  during  the  period.  The  inventory  of  mer- 
chandise on  hand  is,  of  course,  a  balance  sheet  element 
since  it  is  an  asset.  This  real  element  can,  in  effect,  be 
subtracted  from  the  total  purchases  by  being  credited 
to  the  Merchandise  account  and  debited  to  an  asset 
account  termed  "Merchandise  Inventory." 

By  crediting  Merchandise  with  the  closing  inven- 
tory, the  balance  sheet  element  has  been  taken  out  of 
the  account  and  consequently  only  the  profit  and  loss 
element  remains.  This  profit  and  loss  element  will 
usually  be  the  gross  profit  and  is  represented  by  a  credit 
balance  in  the  Merchandise  account.  This  credit  balance 
is  then  treated  like  the  credit  balance  of  any  other  profit 
and  loss  account  which  represents  income. 

5.  Treatment  of  Other  Mixed  Accounts 

In  adjusting  the  Merchandise  account,  the  real 
element,  the  merchandise  on  hand,  is  taken  out  of 
it  and  transferred  to  a  new  account,  leaving  only  the 
element  of  gain  which  is  then  ready  for  transfer  to 


82  THE  LEDGER 

Profit  and  Loss  account,  as  will  be  explained  in  the  fol- 
lowing section.  There  are,  however,  other  mixed 
accounts  which  require  different  treatment.  An  account 
representing  furniture  and  fixtures,  for  example,  will 
become  a  mixed  account  with  the  passage  of  time  be- 
cause such  an  asset  depreciates — that  is,  it  will  be  re- 
duced in  value  through  use.  If  such  an  asset  costs  $100 
and  its  life  is  estimated  to  be  ten  years,  at  the  end  of 
the  first  year  the  asset  would  be  worth  approximately 
$90,  though  the  account  which  represents  it  still  has  a 
debit  balance  of  $100.  To  adjust  a  mixed  account  of 
this  sort,  an  adjusting  entry  is  made  which  credits 
Furniture  and  Fixtures  with  $10,  the  depreciation  for 
the  period,  and  debits  a  new  account,  "Depreciation," 
which  is  purely  an  expense  or  nominal  account.  The 
nominal  element  is  thus  removed,  leaving  the  asset 
account  purely  real.  The  modern  practice  of  making 
the  credit  in  such  a  case  to  a  separate  account  known  as 
Reserve  for  Depreciation,  instead  of  directly  to  the 
asset  account,  will  be  explained  in  a  subsequent 
chapter.  In  principle  the  credit  can  be  made  directly 
to  the  asset  account.  The  effect  of  the  entry  in  either 
case  is  to  remove  the  nominal  element  from  the  account 
and  leave  the  real. 

From  the  foregoing  explanation  it  follows  that  at 
the  end  of  each  fiscal  period  all  accounts  must  be  closely 
scrutinized  to  ascertain  which  represent  income  and 
which  expense  elements.  When  an  account  is  found  to 
be  mixed  in  that  it  includes  both  profit  and  loss  and  bal- 
ance sheet  elements,  it  must  be  simplified  by  removing 
one  or  the  other  so  that  the  profit  and  loss  elements  can 
be  clearly  ascertained.  Such  adjusting  entries  must  pro- 


DETERMINATION  OF  PROFIT  OR  LOSS  83 

vide  not  only  for  the  adjustment  of  items  already  on  the 
books  as  in  the  two  foregoing  illustrations,  but  they  must 
also  set  up  on  the  books  any  income  or  expense  items 
applicable  to  the  period  but  not  yet  recorded. 

The  most  common  example  of  such  an  item  is  that 
of  an  accrued  pay-roll.  When  a  fiscal  period  ends  in 
the  middle  of  a  pay-roll  week,  an  entry  should  be  made 
debiting  Wages  and  crediting  Accrued  Pay-roll  for 
one-half  of  the  weekly  total,  in  order  to  record  all 
wages  expense  applicable  to  the  fiscal  period.  The 
same  procedure  is  applied  to  income  items,  when,  for 
example,  a  commission  or  fee  has  been  earned  but  not 
yet  recorded.  In  the  latter  case  an  entry  must  be  made 
debiting  the  person  who  owes  the  fee  and  crediting  an 
income  account.  After  all  adjusting  entries  have  been 
made,  the  accounts  will  then  consist  of  clearly  defined 
profit  and  loss  accounts  on  the  one  hand  and  balance 
sheet  accounts  on  the  other. 

6.   Closing  Entries 

The  problem  of  transferring  the  balances  of  the 
profit  and  loss  accounts  to  the  Capital  account  has  now 
to  be  considered.  Simplicity  in  the  accounts  is  much  to 
be  desired.  Consequently  a  method  has  been  devised 
of  transferring  the  profit  and  loss  balances  first  to  a 
clearing  house  account  in  which  the  excess  of  the  income 
items  over  the  expense  items,  or  vice  versa,  can  be  deter- 
mined. The  entries  by  which  these  transfers  are  effected 
are  known  as  closing  entries,  and  the  clearing  house 
account  is  known  as  a  Profit  and  Loss  account.  Once 
having  determined  the  balance  of  the  Profit  and  Loss 
account,  that  amount  only  is  transferred  to  the  Capital 


84-  THE  LEDGER 

account  as  representing  the  profit  or  the  loss,  as  the  case 
may  be,  during  the  fiscal  period. 

A  Profit  and  Loss  account  should  be  opened  in  the 
books  only  at  the  close  of  each  fiscal  period  and  only 
for  the  purpose  of  providing  one  account  to  which  the 
balances  of  all  nominal  accounts  can  be  transferred  for 
comparison.  Some  bookkeepers  open  a  Profit  and  Loss 
account  during  a  fiscal  period  and  charge  or  credit  it 
with  unusual  items  such  as  legal  fees  or  profits  on  the 
sale  of  fixed  assets.  Such  practice  is  not  sound.  Un- 
usual items  of  profit  or  loss  should  be  debited  or  credited 
to  accounts  with  a  descriptive  title,  and  the  Profit  or 
Loss  account  should  be  used  only  as  a  clearing  house 
account  at  the  end  of  a  fiscal  period. 

7.    Example  of  Closing  Entries 

An  example  of  a  few  simple  closing  entries  will 
clarify  the  above  description.  Assume  that  a  trial 
balance  at  December  31,  1919,  contains  the  following 
balances : 

Merchandise  Inventory,  January  1,  1919..  $  5,346.00 

Purchases    38,357.00 

Wages    6,941.00 

Rent    2,400.00 

Advertising    947.00 

Insurance   78.00 

General  Expense 3,479.00 

Sales   $69,342.00 

The  first  step  in  determining  the  profit  or  loss  for 
the  year  is  to  take  an  inventory  which  in  this  case  may 
be  assumed  to  be  $4,462.  It  will  be  noticed  that  instead 
of  one  comprehensive  merchandise  account,  this  trial 


DETERMINATION  OF  PROFIT  OR  LOSS  85 

balance  shows  accounts  kept  with  inventory,  purchases, 
and  sales.  This  segregation  of  like  items  is  considered 
better  practice  because  it  obviates  a  mixed  merchandise 
account. 

The  adjusting  entries  to  determine  the  gross  profit, 
which  is  the  excess  of  selling  price  over  the  cost  of  goods 
sold,  are  made  by  debiting  Profit  and  Loss  with  the 
balance  of  Purchases  and  of  the  opening  Merchandise 
Inventory  account  ($38,357  +  $5,346  =  $43,703),  and 
crediting  Profit  and  Loss  with  the  balance  of  Sales 
account  plus  the  value  of  the  closing  inventory 
($69,342  +  $4,462  =  $73,804) ,  the  excess  of  the  credits 
representing  the  gross  profit.  The  gross  profit  may 
thus  be  stated  as  being  the  excess  of  sales  and  closing 
inventory  over  beginning  inventory  and  purchases. 

The  subtraction  of  one  from  the  other  to  arrive  at 
this  gross  profit  is  obtained  by  placing  the  items  on 
opposite  sides  of  the  Profit  and  Loss  account  as  shown 
below.  It  would  not  only  be  inconvenient  to  make  actual 
subtractions  on  one  side  of  the  ledger  account  but  it 
would  be  highly  confusing  to  add  certain  figures  in  one 
column  and  subtract  other  figures  in  the  same  column. 

The  net  profit  is  determined  by  deducting  the 
expenses  for  the  period  from  the  gross  profit.  Ex- 
penses, as  we  have  seen,  are  invariably  debits  to 
appropriate  accounts.  Therefore,  these  accounts  are 
closed  by  debiting  Profit  and  Loss  with  the  amounts 
accumulated  in  the  respective  accounts.  The  following 
outline  account  will  make  the  procedure  clear,  it  being 
understood  that  each  of  the  entries  shown  has  its  corre- 
sponding debit  or  credit  in  another  account  of  the  same 
name: 


86 


THE  LEDGER 


Profit  and  Loss 


Merchandise       Inventory, 

January  1,  1919 $  5,346.00 

Purchases  38,357.00 

Wages   6,941.00 

Rent 2,400.00 

Advertising 947.00 

Insurance   78.00 

General  Expense 3,479.00 

Net    Profit 16,256.00 


Sales   $69,342.00 

Inventory,    December   31, 

1919 4,462.00 


$73,804.00 


$73,804.00 


The  balance  of  the  above  account  is  the  net  profit 
$16,256,  which  amount  is  credited  to  Capital  account. 
Net  profit,  however,  is  not  always  closed  into  Capital 
in  this  way.  If  drawings  have  been  made  from  profits 
by  the  proprietor  for  his  personal  use,  these  items  should 
properly  have  been  debited  to  a  "Drawing"  account. 
Where  such  an  account  exists,  it  is  sometimes  considered 
better  practice  to  transfer  the  balance  of  Profit  and 
Loss,  if  a  profit,  to  this  Drawing  account  so  that  the 
profit  earned  can  be  compared  with  the  drawings,  to 
ascertain  whether  or  not  all  the  profit  has  been  with- 
drawn. If,  on  the  other  hand,  the  Profit  and  Loss 
account  shows  a  loss,  it  is  generally  better  to  transfer 
this  debit  balance  directly  to  the  Capital  account,  to 
which  should  also  be  transferred  the  balance  of  the 
Drawing  account.  In  this  way  any  decrease  in  capital 
will  be  accounted  for  by  showing  how  much  has  been 
lost  in  the  operation  of  the  business  and  how  much  has 
been  withdrawn.  The  significance  of  these  figures  is 
apparent  when  it  is  realized  that  withdrawals  are  with- 
drawals of  capital  or  profits  and  are  not  expenses. 


DETERMINATION  OF  PROFIT  OR  LOSS  87 

8.    Proof  of  Correctness  of  Profit  and  Loss 

After  all  nominal  accounts  have  been  closed  into 
Profit  and  Loss,  which  in  turn  has  been  closed  into 
Capital,  it  follows  that  only  balance  sheet  accounts  re- 
main open  on  the  ledger.  These  will  then  show  the 
assets,  liabilities,  and  capital  of  the  business  in  the  same 
way  that  they  showed  these  facts  at  the  beginning  of  the 
fiscal  period.  A  proof  of  the  correctness  of  the  Profit 
and  Loss  account  can  be  secured  by  comparing  the 
capital  at  the  end  of  the  fiscal  period  with  that  at  the 
beginning. 

The  changes  in  the  capital  through  the  fiscal  period 
may  have  been  due  to  contributions  of  capital,  with- 
drawals of  capital,  and  to  a  profit  or  loss.  If  all  these 
elements  are  correctly  recorded  in  drawing  and  nominal 
accounts,  and  if  these  accounts  have  been  correctly 
transferred  to  Capital  account,  the  ledger  should  be  in 
balance  at  the  end  of  the  fiscal  period  after  the  closing 
entries  have  been  made.  The  increase  or  decrease  in 
capital  during  the  period,  that  is  to  say,  the  change  in 
the  balance  of  capital  from  the  beginning  of  the  period 
to  the  end  of  the  period,  must  be  exactly  accounted  for 
by  contributions  and  withdrawals  on  the  part  of  the 
proprietor  and  by  the  balance  of  the  Profit  and  Loss 
account  transferred  to  Capital. 


REVIEW  QUESTIONS 

1.  What  is  the  purpose  of  financial  statements? 

2.  Why  cannot  a  standard  form  be  given  for  the  profit  and  loss 

statement? 


88  THE  LEDGER 

3.  What  adjustments  of  the  ledger  accounts  are  necessary  to  form 

financial  statements? 

4.  (a)    Criticize  the  Merchandise  account  as  ordinarily  kept, 
(b)    Suggest  a  remedy. 

5.  How  is  profit  and  loss  determined  from  a  set  of  books? 

6.  State  the  process  of  closing  a  ledger. 


CHAPTER    IX 

STATEMENT  OF  TRADING  AND  PROFIT 
AND  LOSS 

1.  Function  of  Statement  of  Profit  and  Loss 

The  function  of  a  statement  of  profit  and  loss  is  to 
set  forth  the  earnings  and  expenses  of  a  business,  both 
from  its  operation  and  from  outside  investments  and 
sources.  Earnings  may  be  defined  briefly  as  increases  in 
capital  not  due  to  contributions  by  proprietors ;  and  ex- 
penses may  be  defined  as  decreases  in  capital  not  due 
to  withdrawals  by  proprietors.  The  statement  of  profit 
and  loss  should  show  all  the  earnings  and  expenses  so 
arranged  and  classified  as  to  disclose  clearly  the  net 
result  of  the  fiscal  period.  It  should  show  them  in  such 
a  way  that  the  management  of  the  business  may  be 
aided  in  its  work  of  increasing  the  net  profits  during 
succeeding  periods.  This  chapter  will  be  devoted  to  a 
discussion  of  the  presentation  of  such  a  statement  in 
adequate  form,  but  it  should  be  borne  in  mind  that  no 
standard  form  is  fixed  either  by  law  or  by  usage.  The 
requirements  of  each  case  should  be  separately  con- 
sidered. The  preparation  of  a  form  that  will  present 
adequately  a  complicated  statement  of  facts  is  some- 
times a  difficult  matter. 

2.  Trial  Balance  Before  Closing 

We  have  seen  that  the  process  of  closing  the  books 
means  transferring  the  balances  in  all  nominal  profit 


90  THE  LEDGER 

and  loss  accounts  to  the  Profit  and  Loss  account,  the 
balance  of  which  is  carried  to  the  Capital  account  either 
directly  or  by  the  way  of  a  Drawing  account.  As  an 
aid  to  the  understanding  of  the  statement  presented  in 
this  chapter,  the  preclosing  trial  balance  is  shown  below 
and  the  closing  entries  are  briefly  summarized: 

CHARLES  TOMPKINS 

TRIAL  BALANCE  BEFORE  CLOSING 

December  81,  1919 

Dr.  Cr. 

Cash $  4,567.00 

Accounts  Receivable 16,627.00 

Merchandise  Inventory,  Jan.  1,  1919  •  •  5,346.00 

Investments    6,000.00 

Furniture  and  Fixtures 3,000.00 

Accounts  Payable $17,327.00 

Charles  Tompkins,  Capital 5,129.00 

Charles  Tompkins,  Drawings 4,421.00 

Sales   69,342.00 

Returned  Sales 113.00 

Purchases 38,357.00 

Returned  Purchases 479.00 

Discount   on   Sales 798.00 

Discount  on  Purchases 692.00 

Interest  on  Investments 400.00 

Wages 6,941.00 

Rent    2,400.00 

Advertising 947.00 

Freight  Inward 195.00 

Freight  Outward 100.00 

Insurance 78.00 

General  Expense 3,479.00 

$93,369.00  $93,369.00 


STATEMENT  OF  PROFIT  AND  LOSS  91 

The  bookkeeping  involved  in  recording  some  of  the 
transactions  summarized  in  the  above  trial  balance  has 
not  yet  been  discussed  and  will  be  taken  up  later.  A 
knowledge,  however,  of  the  procedure  is  not  necessary 
to  understand  the  purpose  and  content  of  a  profit  and 
loss  statement.  The  point  to  note  in  the  foregoing  trial 
balance  is  that  assets  and  expenses  appear  on  the  debit 
side,  liabilities  and  capital  on  the  credit  side,  and  that 
the  items  "Returned  Sales"  and  "Discount  on  Sales" 
are  debits,  and  "Returned  Purchases"  and  "Discount 
on  Purchases,"  are  credits,  because  they  are  deductions 
from,  or  offsets  to,  Sales  and  Purchases  accounts  re- 
spectively. A  deduction  or  subtraction  from  an  account, 
as  we  have  seen,  is  made  by  entry  on  the  opposite  side 
from  which  transactions  in  such  an  account  normally 
appear.  With  this  explanation  the  procedure  in  pre- 
paring closing  entries  and  drawing  up  a  profit  and  loss 
statement  can  now  be  discussed. 

3.    Preparation  of  Closing  Entries 

After  the  trial  balance  has  been  taken  off,  closing 
entries  should  be  prepared  to  transfer  the  balances  of 
all  nominal  accounts  to  the  Profit  and  Loss  account. 
The  balance  of  the  latter  account  should  then  be  trans- 
ferred to  the  Capital  account. 

The  first  step  in  preparing  these  closing  entries  is 
to  record  the  inventory  at  December  31,  1919,  which  in 
this  case  is  assumed  to  be  $4,462.  In  ordinary  books  of 
account  such  as  those  kept  by  trading  concerns,  the 
amount  of  the  closing  inventory  is  not  disclosed  by  the 
accounts  but  must  be  determined  either  by  counting  the 
actual  stock  or  by  estimate.     Since  this  closing  inven- 


92  THE  LEDGER 

tory  is  the  amount  of  merchandise  purchased  but  still 
remaining  on  hand,  the  inventory  should  be  valued  at 
purchase  or  cost  price  because  the  amount  of  it  must  be 
deducted  from  the  purchases  in  order  to  determine  the 
cost  of  the  merchandise  sold.  Conservative  practice, 
for  reasons  to  be  explained  in  a  later  volume,  demands 
that  the  inventory  be  valued  at  purchase  or  market 
price,  using  the  lower  of  the  two. 

The  closing  entries  for  the  illustrative  example  are 
not  given  in  detail  because  they  do  not  differ  from  the 
usual  form  explained  in  the  preceding  chapter. 

4.   Incorrect  Statement 

The  correct  method  of  presenting  in  the  form  of  a 
profit  and  loss  statement  the  data  shown  in  the  above 
trial  balance  can  be  made  clearer  by  its  presentation 
first  in  an  obviously  faulty  form  for  the  purpose  of 
criticism  and  discussion.  Statements  as  incorrect  as  the 
one  shown  below  are  frequently  found  by  accountants 
in  public  practice.  The  correct  form  of  such  a  state- 
ment will  be  given  later  and  by  comparing  the  correct 
with  the  incorrect  method  when  reading  the  text,  a  clear 
conception  will  be  gained  of  its  proper  form  and 
arrangement. 

CHARLES  TOMPKINS 

STATEMENT  OF  INCOME  AND  EXPENDITURE 

December  81,  1919 
Income : 

Sales,  Gross $69,342.00 

Closing  Inventory 4,462.00 

Returned  Purchases 479.00 


STATEMENT  OF  PROFIT  AND  LOSS  93 

Discount  on  Purchases 692.00 

Interest  on  Investments 400.00           $75,375.00 

Expenditure: 

Purchases,  Gross $38,357.00 

Returned  Sales 1 13.00 

Opening  Inventory 5,346.00 

Discount  on  Sales 798.00 

Wages    of    Employees 6,941.00 

Rent    2,400.00 

Advertising 947.00 

Insurance    78.00 

Freight  and  Cartage-In 195.00 

Freight  and  Cartage-Out 100.00 

General  Expense 3,479.00              58,754.00 


Final  Profit $16,621.00 


5.    Title  of  Statement 

The  title  as  shown  above,  "Statement  of  Income 
and  Expenditure,  December  31,  1919,"  is  incorrect  in 
several  particulars,  principally  with  regard  to  the  date. 
This  kind  of  statement,  unlike  a  balance  sheet,  is 
designed  to  show  the  results  of  operation  of  the  business 
during  a  period  of  time,  and  consequently  the  period 
should  be  designated.  In  the  title  above  only  one  date 
is  given,  which  would  reasonably  be  taken  to  be  the 
ending  date,  although  it  is  not  so  specified.  The  period 
should  be  described  either  by  stating  the  length  of  time, 
for  example,  one  year  ended  December  31,  1919 — 
or  by  specifying  both  the  beginning  and  the  ending 
dates.  It  will  be  assumed  that  this  statement  covered 
the  year  ended  December  31,  1919. 

Another  error  in  the  title  of  the  statement  is  the  use 


94  THE  LEDGER 

of  the  word  "expenditure."  This  is  obviously  due  to  a 
confusion  between  the  words  "expenditure"  and  "ex- 
pense," which  are  not  synonymous,  although  frequently 
so  used.  An  expenditure  is  a  payment  or  an  obligation 
to  pay  for  something  and  it  may  or  may  not  be  an  ex- 
pense, depending  upon  the  nature  of  the  services  or 
thing  acquired  by  the  expenditure ;  for  example,  a  pay- 
ment or  obligation  to  pay  for  a  fixed  or  permanent  asset 
is  called  a  capital  expenditure  and  is  not  an  expense. 
On  the  other  hand,  an  expenditure  for  wages  is  called 
a  revenue  expenditure  and  does  result  in  an  expense.  If 
this  kind  of  title  is  to  be  used  it  should  be  stated  as  "In- 
come and  Expense." 

There  is  considerable  difference  of  opinion  as  to  the 
proper  title.  Some  persons  prefer  to  use  the  term 
"Income,  Profit  and  Loss,"  others  prefer  "Profit  and 
Loss,"  while  in  certain  classes  of  business  the  form 
is  "Revenue  and  Expense,"  and  in  still  others,  the 
statement  would  be  entitled  "Income  Statement."  Pos- 
sibly the  most  exact  title  for  a  statement  such  as  the 
one  under  discussion  is  "Statement  of  Income  and 
Profit  and  Loss,"  and  this  title  is  used  in  the  amended 
statement  shown  in  §  15.  It  is  selected  because  certain 
items  appear  on  the  statement  which  do  not  result 
strictly  from  the  operation  of  the  business,  such  as  in- 
terest on  investments,  an  income  rather  than  a  profit. 

6.     Form  of  Statement 

The  statement  is  presented  in  what  is  known  as  the 
running  or  statement  form.  Another  form  widely  used 
shows  expenses  on  the  left  and  income  on  the  right 
side,  with  a  balance  of  profit  and  loss,  as  the  case  may 


STATEMENT  OF  PROFIT  AND  LOSS  95 

require,  inserted  to  make  the  totals  of  the  two  sides 
equal.  This,  known  as  the  account  form,  is  not  to  be 
recommended  for  general  use.  It  is  somewhat  technical 
and  less  easily  understood  than  the  running  form  in 
which  the  income  items  are  placed  first  and  the  expenses 
deducted  from  them,  leaving  the  net  profit  or  loss,  as 
the  case  may  require,  shown  at  the  bottom. 

Frequently  a  profit  and  loss  statement  is  described 
as  a  "Profit  and  Loss  Account."  Care  should  be  taken 
to  ascertain  whether  the  term  refers  to  a  transcript  of 
the  Profit  and  Loss  account  as  it  appears  in  the  ledger, 
or  to  a  statement  of  profit  and  loss  prepared  from  the 
ledger.  The  latter  assumption  would  be  correct  if  there 
were  no  definite  indication  that  the  former  kind  of  state- 
ment was  intended.  This  confusion  is  due  to  a  loose 
use  of  "account,"  which  is  not  a  statement,  but  a  col- 
lection in  a  ledger  of  the  debits  and  credits  concerning 
a  specified  property,  person,  income,  or  expense. 

On  the  statement  as  amended  in  §  15,  the  items  are 
grouped  in  the  endeavor  to  give  the  utmost  information 
to  a  person  untrained  in  bookkeeping  or  the  use  of 
accounting  statements.  A  fundamental  rule  in  state- 
ment preparation  is  that  figures  should  be  so  clearly 
arranged  that  any  person  of  ordinary  intelligence  can 
understand  them.  A  further  rule  is  to  show  the  results 
of  the  various  operations  when  this  is  possible. 

7.     Deductions   from   Sales 

Listed  among  the  expenses  is  an  item  for  returned 
sales  amounting  to  $113.  This  is  not  an  expense  but  a 
cancellation  of  sales  due  to  returns  by  customers  of 
merchandise  which  the  sellers  were  willing  to  receive  in 


96  THE  LEDGER 

cancellation  of  the  buyer's  obligation.  In  order,  there- 
fore, to  state  the  actual  sales  it  is  necessary  to  deduct 
the  returns  from  the  gross  sales;  this  has  been  done  on 
the  corrected  statement,  the  net  sales  shown  as  $69,229. 

Some  accountants  prefer  to  deduct  also  the  freight 
and  cartage-out  on  the  theory  that  the  selling  price, 
which,  of  course,  was  credited  to  sales,  included  a  charge 
for  freight  either  expressly  stated  or  included  as  an  in- 
crease of  selling  price.  It  is  probably  not  the  general 
practice  to  deduct  freight  and  cartage-out,  and  it 
should  not  be  done  unless  the  facts  clearly  show  that  the 
cost  of  such  freight  was  really  included  in  some  way  in 
the  selling  price  charged  to  the  customers  and  credited 
to  sales. 

Sometimes  the  discount  on  sales  is  deducted  from 
the  total  sales  in  order  to  determine  the  net  sales,  but 
this  would  rarely  be  correct,  as  explained  below. 

8.    Cost  of  Goods  Sold 

In  order  to  determine  the  gross  profit  it  is  necessary 
to  deduct  from  the  sales  the  cost  of  the  goods  sold,  and 
this  cost  is  determined,  as  shown  on  the  corrected  form 
of  statement  in  §  15,  by  adding  the  purchases  to  the 
beginning  inventory  and  deducting  the  closing  inven- 
tory from  the  total.  In  the  preparation  of  this  part  of 
the  statement  three  items  require  particular  mention. 

The  returned  purchases  of  $479  are  deducted  from 
the  gross  purchases  of  $38,357,  leaving  the  net  $37,878, 
as  shown  in  the  corrected  statement.  These  returned 
purchases  are  similar  to  returned  sales  and  therefore 
are  deducted  from  the  gross  in  order  to  ascertain  the 
real  or  net  amount  of  purchases. 


STATEMENT  OF  PROFIT  AND  LOSS  97 

Freight  and  cartage-in  are  added  with  the  purchases 
to  the  beginning  inventory  because  the  figure  desired  is 
the  cost  of  procuring  the  merchandise  to  be  sold.  One 
element  of  such  cost  is  the  expense  of  getting  it  to  the 
place  of  sale.  If  the  seller  of  the  merchandise  prepays 
the  freight  and  charges  the  firm  for  the  cost  of  the  mer- 
chandise together  with  the  freight,  the  firm  does  not 
keep  an  account  for  the  inward  freight,  but  charges  the 
Purchases  account  with  the  amount  of  the  invoice,  which 
includes  the  freight.  When,  however,  the  firm  as 
buyer  pays  such  freight  it  keeps  account  of  it,  but  this 
freight  should  not  be  regarded  as  an  expense.  It  really 
is  a  part  of  the  merchandise  purchases  account. 
Although  kept  separate  for  bookkeeping  reasons,  these 
two  accounts  are  combined  in  the  preparation  of  a  state- 
ment of  profit  and  loss  for  determination  of  the  cost  of 
procuring  merchandise  for  sale. 

The  discount  on  purchases  of  $692  is  not  deducted 
from  the  gross  purchases  for  the  same  reasons  that  dis- 
count on  sales  is  not  deducted  from  sales.  These 
accounts  will  be  discussed  in  a  later  paragraph. 

The  total  cost  of  goods  sold,  as  shown  by  the  cor- 
rected statement,  is  $38,957,  which  is  subtracted  from 
the  net  sales  of  $69,229  to  give  the  gross  profit  of 
$30,272. 

9.    Expenses 

Where  the  expenses  of  selling  have  been  kept  in 
sufficient  detail  it  is  advisable  to  show  them  in  a  separate 
section  under  such  a  caption  as  "Selling  Expenses." 
When  this  is  done,  the  deduction  of  selling  expenses 
from  gross  profit  leaves  what  is  usually  designated  as 


98  THE  LEDGER 

"Net  Profit  on  Sales."  In  the  case  under  discussion 
only  two  items  relate  strictly  to  selling,  namely,  adver- 
tising and  freight  and  cartage-out.  Where  the  items 
are  so  few,  listing  them  in  a  separate  section  tends  to 
make  the  statement  unnecessarily  complicated.  Hence, 
in  the  amended  statement,  these  selling  expenses  are 
grouped  with  the  general  or  administrative  expenses 
under  the  caption  of  "Expenses." 

10.     Prepayments 

Among  the  expenses  listed  in  the  statement  are 
advertising,  rent,  and  insurance.  Insurance  is  usually 
paid  in  advance  for  one  or  more  years;  rent  frequently 
is  paid  in  advance,  particularly  when  payable  quarterly ; 
and  advertising  is  sometimes  undertaken  on  a  large 
scale  involving  heavy  initial  outlay,  from  which  the 
business  will  profit  in  subsequent  years.  In  any  of  these 
cases  it  would  be  inexact  to  charge  the  total  of  these 
payments  as  expenses  applicable  to  the  current  year. 
Consequently,  the  portion  really  applicable  to  the  cur- 
rent year  is  ascertained  in  the  most  practicable  manner, 
and  that  portion  only  should  be  stated  as  expense,  the 
balance  being  carried  in  the  balance  sheet  as  a  "de- 
ferred" charge,  i.e.,  a  sort  of  temporary  asset,  which  will 
be  decreased  as  the  value  of  the  service  prepaid  is  con- 
sumed. In  the  case  under  discussion  there  is  nothing  to 
indicate  that  any  part  of  these  expenses  is  applicable 
to  subsequent  years;  consequently  the  full  amounts 
stand  as  expense  of  the  current  year. 

When  the  general  expense  is  large,  some  explana- 
tion should  be  given  to  show  what  items  have  been  in- 
cluded therein.     An  analysis  stating  separately  each 


STATEMENT  OF  PROFIT  AND  LOSS  99 

principal  kind  of  expense  included  in  it  is  usually  the 
most  convenient  form  of  explanation.  Many  book- 
keepers are  prone  to  charge  to  general  expense  any 
unusual  item  which  cannot  readily  be  classified,  regard- 
less of  its  nature  and  amount.  Such  procedure  obscures 
the  accounts.  When  large  or  unusual  items  of  expense 
are  incurred  they  should  not  be  "buried"  in  general  ex- 
pense but  should  be  shown  separately  on  the  statement. 

11.    Capital   Income  and   Expense 

Frequently  both  expenses  and  income  do  not  result 
directly  from  trading  or  selling  but  are  incidental  to 
the  operation  of  the  business  as  is  shown  in  the  case 
under  discussion  by  the  discounts  on  purchases  and 
sales.  These  are  assumed  to  be  cash  discounts  or 
allowances  for  the  payment  of  bills  prior  to  their  actual 
due  dates.  They  do  not  reduce  the  purchase  or  selling 
prices  of  merchandise,  but  are  allowances  or  rebates  to 
induce  prompt  payment.  While  it  is  true  that  cash 
discounts  on  sales  are  generally  beyond  the  control  of 
the  seller,  since  he  cannot  foretell  which  of  his  customers 
will  take  advantage  of  them,  nevertheless  such  discounts 
are  of  the  same  nature  as  those  on  purchases  which  the 
firm  itself  takes.  Consequently,  it  is  reasonable  to  sub- 
tract one  kind  of  discount  from  the  other  and  to  show 
on  the  statement  the  excess  as  an  income  or  expense. 
Since  such  items  relate  to  the  securing  of  capital,  they 
may  properly  be  listed  as  "Capital  Income  and  Ex- 
pense." 

As  is  explained  in  Chapter  XXV  of  this  volume, 
cash  discounts  should  not  be  confused  with  trade  dis- 
counts.    The  latter  are  deductions  from  catalogue  or 


100  THE  LEDGER 

list  prices  merely  to  fix  the  selling  or  purchase  price  of 
an  article.  When  once  determined  this  is  the  only  price 
which  appears  on  the  bill  or  invoice ;  consequently  trade 
discount  ordinarily  does  not  show  in  the  accounts  of 
either  the  seller  or  the  buyer.  Trade  discounts  are  em- 
ployed to  obviate  the  reprinting  of  catalogues  or  price 
lists  whenever  the  market  price  fluctuates,  and  also  to 
provide  a  means  of  making  special  prices  to  customers 
who  are  to  be  favored  because  of  large  purchases,  good 
credit,  or  other  considerations. 

12.  Other  Income 

After  the  net  profit  on  the  operation  of  the  business 
has  been  determined,  interest  on  investments  must  be 
considered.  As  these  investments  are  not  necessary 
in  the  conduct  of  the  business,  the  income  derived  from 
them  is  not  an  earning  of  the  business  and  is  therefore 
shown  separately  on  the  statement.  The  total  of  such 
income  and  the  net  profit  on  operation  is  the  net  income. 

13.  Net  Income  Credited  to  Capital  Account 

On  the  statement  presented  for  criticism  the  net  in- 
come credited  to  capital  is  designated  as  "Final  Profit." 
That  term  is  not  explicit.  In  the  statement  as  corrected 
it  is  "Net  Income  Credited  to  Capital  Account." 

14.  Closing  Drawing  Accounts 

Sometimes  drawing  accounts  are  closed  directly  into 
the  Capital  account.  But,  as  already  explained,  an- 
other method  is  to  credit  profits  to  the  Drawing  ac- 
count and  then  to  close  the  balance  of  the  latter  into  the 
Capital  account.     This  has  the  advantage  of  showing 


STATEMENT  OF  PROFIT  AND  LOSS  101 

in  the  Drawing  account  how  much  profit  can  be  with- 
drawn without  impairing  the  capital  and  also  the 
amount  actually  withdrawn.  It  thus  becomes  apparent 
whether  or  not  capital  has  been  decreased.  If  draw- 
ings do  not  equal  profits,  the  Drawing  account  will 
have  a  credit  balance  which  really  represents  profits  left 
in  the  business  and  therefore  constitutes  an  increase  in 
capital. 

If,  however,  there  has  been  a  loss,  the  loss  together 
with  any  drawings  should  be  charged  directly  to  the 
Capital  account.  The  reason  for  this  distinction  is  that 
if  the  loss  be  charged  to  a  Drawing  account  and  then 
the  total  of  that  account  be  transferred  to  Capital,  the 
latter  will  not  indicate  separately  the  amount  of  draw- 
ings and  the  amount  of  the  loss. 

15.    Corrected  Statement 

The  various  changes  explained  above  are  illustrated 
in  the  following  example : 

CHARLES  TOMPKINS 

STATEMENT  OF  INCOME  AND  PROFIT  AND  LOSS 

For  the  Year  Ended  December  81,  1919 
Sales : 

Gross $69,342.00 

Less  Returned  Sales 1 13.00 

Net  Sales $69,229.00 

Cost  of  Goods  Sold: 

Inventory,  January  1,  1919 $5,346.00 

Purchases $38,357.00 

.  Less  Returned  Purchases       479.00     37,878.00 


102  THE  LEDGER 

Freight   and    Cartage-In 195.00 

$43,419.00 
Less  Inventory,  December,  31,  1919.        4,462.00 

Total  Cost  of  Goods  Sold 38,957.00 

Gross  Profit $30,272.00 

Expense: 

Advertising $  947.00 

Freight  and  Cartage-Out 100.00 

Wages  of  Employees 6,941.00 

Rent    2,400.00 

General  Expense 3,479.00 

Insurance    78.00 

Total 13,945.00 


Net  Profit  on  Sales $16,327.00 

Capital  Income  and  Expense: 

Discount   on   Sales $798.00 

Less  Discount  on  Purchases 692.00  106.00 


Net  Profit  on  Operations $16,221.00 

Other  Income: 

Interest   on    Investments 400.00 

Net  Income  for  Period  Credited  to  Capital  Account  $16,621.00 

16.    Balance  Sheet 

After  the  closing  entries  have  been  made,  the  finan- 
cial condition  of  Charles  Tompkins  can  be  indicated  by 
the  following  balance  sheet : 


STATEMENT  OF  PROFIT  AND  LOSS  103 

CHARLES  TOMPKINS 

BALANCE   SHEET 

December    81,    1919 

Assets 

Cash    $  4,567.00 

Accounts  Receivable 16,627.00 

Merchandise  Inventory 4,462.00 

Investments    6,000.00 

Furniture  and  Fixtures 3,000.00 


$34,656.00 


Liabilities  and  Capital 

Accounts  Payable $17,327.00 

Charles  Tompkins,  Capital 17,329.00 


$34,656.00 


REVIEW  QUESTIONS 

Prepare  a  statement  of  trading,  and  profit  and  loss  from  the 
trial  balance  as  prepared  in  answer  to  Question  4  of  Chapter 
VII.  In  this  connection,  take  into  consideration  the  inven- 
tory on  December  31,  end  of  year,  which  amounts  to  $90,000. 

Take  a  trial  balance  of  the  accounts  left  on  the  ledger  after  the 
profit  and  loss  accounts  have  been  closed  out,  and  the  net 
profit  transferred  to  capital.  (This  trial  balance  acts  as  test 
of  the  accuracy  of  the  profit  as  determined.  From  it  the 
balance  sheet  will  be  prepared  as  explained  in  Chapter  XL) 


CHAPTER   X 

STATEMENT    OF    CASH    RECEIPTS    AND 
PAYMENTS 

1.      Use  of  Cash   Statements 

A  statement  of  cash  receipts  and  payments  is  useful 
in  presenting  an  analysis  of  the  cash  transactions  which 
are  stated  in  summary  form  in  the  cash  account  in  the 
ledger.  These  transactions  are  itemized  in  the  cash 
book,  as  explained  in  Chapter  XVII,  but  there  they  are 
recorded  chronologically  and  thus  the  receipts  and  pay- 
ments are  not  classified  by  sources  and  purposes.  Such 
classification  is  essential  for  administrative  control  in 
order  to  test  the  integrity  of  the  cashiers  and  also  to 
forecast  the  probable  receipts  and  payments  of  succeed- 
ing periods. 

Sometimes  an  attempt  is  made  to  use  a  statement  of 
cash  receipts  and  payments  to  indicate  the  profit  or  loss 
of  the  business.  Profit  or  loss,  however,  cannot  be  indi- 
cated even  with  approximate  accuracy  by  a  cash  state- 
ment, as  will  appear  from  the  following  discussion. 
This  limitation  of  the  statement  of  cash  receipts  and 
payments  is  not  as  generally  understood  as  it  should  be ; 
hence,  this  chapter  presents  and  discusses  a  typical  cash 
statement,  pointing  out  its  legimate  uses  and  the  rea- 
sons why  it  does  not  disclose  the  profit  or  loss  of  the 
business.  This  chapter  should  be  carefully  read  in  the 
light  of  the  discussion  in  Chapter  IX  to  which  frequent 
reference  should  be  made. 

104 


CASH    STATEMENTS  105 

2.  Form  and  Content 

A  statement  of  cash  receipts  and  payments  should 
show  the  balance  of  cash  on  hand  at  the  beginning  of  a 
period,  the  amounts  of  cash  received  and  paid  during  the 
period,  and  the  balance  of  cash  on  hand  at  the  end  of 
the  period.  The  form  of  such  a  statement  and  the 
amount  of  detail  which  it  should  disclose  are  matters  of 
judgment.  Sometimes  the  double  or  account  form  is 
used,  showing  the  beginning  balance  and  the  receipts 
upon  the  left  side  and  the  payments  and  closing  balance 
on  the  right.  Again,  the  running  form  of  statement  is 
used  in  which  the  opening  balance  is  shown  first,  fol- 
lowed by  the  receipts ;  from  the  total  of  these  two  classes 
of  items  the  payments  are  deducted,  and  thus  the  closing 
balance  is  left  at  the  bottom.  This  closing  balance 
should  agree  with  the  cash  balance  displayed  in  the  bal- 
ance sheet  as  of  the  closing  date.  Whenever  a  sup- 
porting schedule  is  used,  care  must  be  exercised  to  make 
sure  that  the  final  figure  shown  by  the  schedule  agrees 
with  the  balance  sheet  figure  which  the  schedule  is  in- 
tended to  amplify  or  explain  (see  Chapter  XIV). 

The  second  or  running  form  of  cash  statement  is 
generally  preferred.  This  form  is  more  easily  read  than 
the  first  one,  because  it  is  not  necessary  to  compare  fig- 
ures which  are  opposite  each  other  as  they  are  in  the 
account  form.  It  is  easier  to  read  down  a  page  than  to 
read  opposite  pages  at  the  same  time. 

3.  Illustrative  Statement 

The  following  is  an  example  of  a  statement  of  cash 
receipts  and  payments.  The  discussion  presented  in 
this  chapter  will  be  based  upon  this  statement. 


106  THE  LEDGER 

ALEXANDER  BISHOP 

STATEMENT  OF  CASH  RECEIPTS  AND  PAYMENTS 
From  January  1,  1918,  to  December  31,  1918 

Balance  in  hand  and  on  deposit,  January  1,  1918.  . .  .      $12,417.82 

Receipts : 

Accounts  Receivable $42,863.27 

Cash  Sales 491.83 

Interest  on  Bonds  Owned 500.00 

Dividends  on  Stocks  Owned 1,250.00 

Interest  on  Bank   Balance 111.42 

Refunds  by  Creditors  for  Overpayment  37.19 

Sale  of  Office  Desk 25.00 

Alexander  Bishop — Additional  Capital.        5,000.00       50,278.71 

Total  Available  Funds $62,696.53 

Payments : 

Accounts  Payable $17,642.54 

Cash  Purchases 872.61 

Show-Cases    2,000.00 

Wages 4,697.82 

Rent    6,000.00 

Advertising 2,462.95 

Freight  Inward 117.89 

Freight  Outward 96.82 

Insurance 378.95 

General    Expense 2,637.41 

Interest  on  Bank  Loan 180.00 

Alexander  Bishop — Drawings 4,735.29       41,822.28 

Balance  in  hand  and  on  deposit,  December  31,  1918,  .      $20,874.25 

4.     Title  of  Statement 

There  is  some  difference  of  opinion  as  to  the  proper 
title  for  a  cash  statement.  Frequently  it  is  termed 
"Statement  of  Cash  Receipts  and  Expenditures."     This 


CASH    STATEMENTS  107 

is  not  an  exact  description  because  the  word  "expendi- 
tures" means  more  than  the  word  "payments."  An 
expenditure  is  a  payment  or  an  obligation  to  pay  for 
something  and  therefore  the  word  includes  more  than 
payments  alone.  Incidentally,  the  word  "expenditure" 
ought  not  to  be  used  in  a  statement  of  profit  and  loss  to 
take  the  place  of  the  word  "expense."  Expenditures, 
it  should  be  remembered,  are  of  two  kinds.  They  in- 
clude not  only  "revenue  expenditures,"  which  constitute 
expense,  but  also  "capital  expenditures,"  which  result 
in  the  acquisition  of  fixed  assets,  and  which  therefore  are 
not  to  be  classified  as  expense. 

Frequently  in  cash  statements  the  word  "disburse- 
ments" will  be  used.  The  word  "payment"  is  prefer- 
able, partly  because  it  is  shorter  and  partly  because  of 
a  slight  difference  of  meaning.  As  defined  by  the  dic- 
tionary, a  payment  is  "an  act  of  paying,  or  that  which 
is  paid;  the  discharge  of  a  debt  or  obligation."  The 
dictionary  definition  of  disbursement  is  "money  ex- 
pended, especially  from  public  funds." 

5.      Dates  of  Statement 

Both  the  beginning  and  ending  dates  are  specified 
in  the,  above  statement.  This  clearly  defines  the  period 
covered.  It  would  not  be  sufficient  to  give  only  the 
ending  date  because  then  the  length  of  the  period  would 
not  be  disclosed.  Another  manner  of  dating,  which  in 
some  cases  is  satisfactory,  is  to  designate  the  period  cov- 
ered and  to  specify  only  the  ending  date;  for  example, 
the  above  statement  might  be  entitled,  "For  the  Year 
Ended  December  31,  1918."  When,  however,  a  cash 
statement  covers  a  period  of  time  less  easily  designated 


108  THE  LEDGER 

than  one  year,  as,  for  example,  an  odd  number  of 
months,  it  is  better  to  mention  both  the  beginning  and 
the  ending  date  in  order  to  fix  definitely  the  beginning 
date.  Statements  should  be  so  prepared  as  to  obviate 
all  avoidable  mental  effort  on  the  part  of  persons  using 
them. 

6.     Details  on  Statement 

The  balances  at  the  beginning  and  the  end  are  de- 
scribed as  "in  hand  and  on  deposit."  As  a  rule  it  is 
unnecessary  to  specify  how  much  of  the  balance  is  on 
deposit  in  banks  or  which  banks  hold  the  deposits  and 
how  much  is  on  hand  in  a  petty  cash  or  other  fund. 
When  such  information  is  important,  the  best  way  to 
show  it,  if  there  are  not  more  than  four  or  five  banks  and 
funds,  is  to  indent  an  itemized  list  of  the  various  items 
and  to  extend  the  total  as  the  balance  in  hand  and  on 
deposit.  If  there  are  more  than  four  or  five,  it  is  advis- 
able to  state  the  balance  as  follows:  "Balance  in  Hand 
and  on  Deposit,  January  1,  1918,  per  Schedule."  A 
schedule  should  then  be  attached  to  the  statement  show- 
ing in  detail  the  location  of  all  the  cash  balances  com- 
posing the  total  amount  at  the  date  specified. 

On  a  cash  statement  the  receipts  and  the  payments 
should  be  indented  so  as  to  show  the  total  of  each.  It 
is  important  to  give  full  information  as  to  actual  receipts 
and  payments  during  the  period  covered,  from  which 
an  estimate  can  be  made  as  to  probable  receipts  and  pay- 
ments during  a  succeeding  similar  period.  A  proprie- 
tor in  his  eagerness  to  make  a  profit  should  not  overlook 
the  equally  important  task  of  providing  funds  with 
which  to  meet  current  obligations. 


CASH    STATEMENTS  109 

7.  Arrangement  of  Items 

To  facilitate  the  use  of  the  statements,  the  detailed 
items  specified  under  receipts  and  payments  should  be 
arranged  in  some  logical  order.  Circumstances  must 
govern  the  determination  of  the  order  to  be  used  in  each 
case,  but  once  an  order  is  adopted,  both  receipts  and  pay- 
ments should  be  listed  according  to  the  same  plan. 
Items  are  arranged  sometimes  in  the  order  of  their 
amounts;  at  other  times  according  to  the  source  of  re- 
ceipts and  kind  of  payments ;  or,  they  may  be  arranged 
alphabetically.  An  established  form  should  be  adhered 
to  in  subsequent  statements  unless  there  is  good  reason 
to  change  it;  every  variation  in  the  form  of  statements 
which  are  successively  prepared  makes  comparisons 
more  difficult.  Statements  should  be  so  designed  that 
items  of  one  year  can  be  compared  quickly  with  similar 
items  in  any  preceding  year. 

The  form  of  the  statement  shown  above  has  some- 
times been  criticized  because  the  total  of  the  opening 
balance  and  the  receipts  is  stated  as  "Total  Available 
Funds,"  whereas  this  total  was  never  wholly  available 
at  any  one  time.  The  criticism  seems  unimportant. 
Some  title  should  be  given  to  the  total  as  a  matter  of 
form  if  for  no  other  reason;  it  does  not  seem  a  misnomer 
to  use  "Total  Available  Funds,"  since  these  funds  repre- 
sent a  total  out  of  which  payments  were  made,  although 
that  total  was  never  wholly  in  hand  at  any  one  time. 

8.  Accounts  Receivable 

Collections  from  accounts  receivable  do  not  neces- 
sarily represent  income  during  the  period  because  a 
large  part  of  the  collections  may  be  on  bills  rendered  for 


110  THE  LEDGER 

goods  sold  at  an  earlier  date;  on  the  other  hand,  at  the 
end  of  the  period  there  may  be  outstanding  accounts 
receivable  which  have  resulted  from  sales  made  during 
the  period. 

When  a  sale  is  made,  the  excess  of  the  selling  price 
over  the  cost  of  the  goods  sold  is  known  as  gross  profit 
and  this  gross  profit  is  an  income  earned  at  the  time  of 
the  sale.  If  the  sale  is  on  credit,  an  account  receivable 
is  created  for  the  amount  due  from  the  customer;  but 
the  collection  of  that  account  has  no  effect  on  the  gross 
profit.  Any  income  from  gross  profit  is  earned  at  the 
time  of  the  sale  and  not  when  an  account  receivable  is 
collected.  Thus  the  total  income  during  a  fiscal  period 
from  gross  profits  is  the  excess  of  selling  prices  of  all 
merchandise  sold  over  the  cost  of  such  merchandise,  re- 
gardless of  whether  the  sales  were  made  for  cash  or  on 
credit  and  regardless  of  the  collections  during  the  period 
from  customers  on  charge  sales. 

9.  Cash  Sales 

The  receipts  from  cash  sales  represent  income  for 
the  period,  provided  all  the  sales  were  made  and  col- 
lected within  the  period.  If,  however,  it  were  the  prac- 
tice to  include  C.  O.  D.  sales  in  this  classification,  there 
might  be  uncollected  shipments  at  the  end  of  the  period 
or  collections  on  prior  shipments.  With  that  exception, 
receipts  from  cash  sales  represent  the  income  from  that 
source. 

10.  Interest  on  Bonds  Owned 

Cash  received  as  bond  interest  represents  bond  in- 
come only  if  the  bond  interest  periods  coincide  exactly 


CASH    STATEMENTS  111 

with  the  fiscal  periods  of  the  business  and  if  the  bond 
coupons  are  collected  on  the  day  they  become  due. 
This  is  rarely  the  case.  Bond  income  really  accrues 
from  day  to  day,  although  it  can  be  collected  only  on 
fixed  dates.  Consequently  bond  income  is  the  coupon 
rate  of  interest  on  par  value  calculated  for  the  fiscal 
period  regardless  of  when  the  coupons  are  actually  col- 
lected. Further,  the  coupon  rate  of  interest  would  not 
be  the  true  rate  of  income  if  the  bonds  were  bought  at  a 
premium  or  at  a  discount.     ( See  Volume  IV. ) 

11.  Dividends  on  Stocks  Owned 

Cash  received  from  dividends  constitutes  income  only 
if  the  dividends  are  paid  within  the  same  fiscal  period  in 
which  they  are  declared.  Dividends,  unlike  interest, 
do  not  accrue  from  day  to  day.  They  should  be  con- 
sidered for  the  period  in  which  they  are  declared,  because 
at  that  time  the  corporation  becomes  indebted  to  the 
stockholder  for  the  amount  of  the  dividend,  the  latter 
acquiring,  by  such  declaration,  an  account  receivable. 
The  collection  of  a  dividend  does  not  affect  the  income 
of  the  stockholder;  it  is  merely  the  conversion  of  an  ac- 
count receivable  into  cash. 

12.  Interest  on  Bank  Balance 

Interest  on  a  bank  balance  accrues  from  day  to  day 
and  is  subject  to  the  same  comments  as  interest  on  bonds, 
except  for  the  feature  of  premium  or  discount  which 
may  be  involved  in  the  latter.  However,  if  the  interest 
is  on  a  savings  bank  account,  a  distinction  exists.  As  a 
rule  savings  banks  do  not  pay  interest,  in  the  strict  sense 
of  the  term;  they  declare  dividends  at  the  end  of  each 


112  THE  LEDGER 

half  year.  The  fact  that  such  dividends  are  usually  at 
a  fixed  rates  does  not  change  their  nature.  Conse- 
quently dividends,  or  so-called  interest,  on  savings  bank 
accounts  should  be  considered  income  as  of  the  date  on 
which  they  are  declared,  which  date  may  or  may  not  fall 
within  the  same  fiscal  period  as  the  day  on  which  they 
are  paid. 

13.  Refunds  by  Creditors  for  Overpayments 

Refunds  by  creditors  for  overpayments  do  not  con- 
stitute income  at  all.  Such  items  are  reductions  in  cash 
payments  made  on  accounts  payable.  While  necessary 
in  a  statement  of  cash  receipts  and  payments,  these  items 
would  not  be  included  in  a  statement  of  profit  and  loss. 

14.  Sale  of  Office  Desk 

Cash  received  for  the  sale  of  a  fixed  or  permanent 
asset  at  its  book  value  does  not  affect  income  in  any  way, 
because  there  is  merely  the  conversion  of  a  fixed  asset 
into  a  current  asset,  without  the  slightest  change  in  the 
capital.  If  the  sales  price  is  lower  than  its  book  value, 
a  loss  is  incurred ;  if  higher,  an  income  is  earned.  Such 
losses  and  incomes  would  not  be  disclosed,  however,  by 
the  mere  statement  of  the  cash  received  on  the  sales. 

15.  Alexander  Bishop — Additional  Capital 

This  receipt  of  cash  has  increased  the  business  capi- 
tal; but  it  does  not  constitute  income  because  it  is  not 
due  to  the  operations  of  the  business.  It  is  necessary 
information  to  be  placed  in  a  cash  statement,  but  it 
would  have  no  place  in  a  profit  and  loss  statement  which 
would  show  only  income  and  expense  items. 


CASH    STATEMENTS  113 

16.  Accounts  Payable 

The  item  of  accounts  payable  is  subject  to  comments 
similar  to  those  made  upon  accounts  receivable.  Ac- 
counts payable  do  not  necessarily  represent  expense  of 
the  business  during  the  period  under  attention.  More- 
over, inasmuch  as  some  of  the  accounts  payable  may  be 
capital  expenditures,  payments  to  creditors  may  not 
represent  expense  at  all. 

17.  Cash  Purchases 

The  item  of  cash  purchases  represents  expense  for 
merchandise  purchases  only  if  the  payments  are  made 
within  the  period  in  which  the  goods  are  received  and 
taken  into  the  inventory. 

18.  Show-Case 

In  the  purchase  of  a  show-case  there  was  merely  the 
conversion  of  a  current  asset,  cash,  into  a  fixed  or  per- 
manent asset,  fixtures.  No  expense  resulted  because 
the  capital  was  not  decreased  by  the  transaction. 

19.  Wages  and  Other  Expenses 

Payments  for  expenses  do  not  represent  the  true 
amount  of  the  expense  for  the  period,  except  in  the  rare 
case  where  no  expenses  were  accrued  either  at  the  begin- 
ning or  at  the  end  of  the  period.  The  time  covered  by 
wage  payments  seldom  terminates  on  the  day  when  pay- 
ment is  made.  Rent  is  frequently  paid  in  advance,  in 
which  event  the  payment  does  not  represent  the  expense 
of  rent,  but  creates  an  asset  known  as  prepaid  expense. 
The  same  is  true  of  advertising  if  a  certain  part  of  it 
clearly  benefits  subsequent  periods ;  and  the  same  is  true 


114  THE  LEDGER 

also  of  insurance  if  premiums  are  paid  for  more  than  the 
current  fiscal  period. 

20.  Alexander  Bishop — Drawings 

Drawings  by  the  proprietor  do  not  constitute  an 
expense  of  the  business,  although  a  nominal  or  arbitrary 
sum  drawn  by  him  is  sometimes  considered  salary.  The 
amount  of  the  so-called  salary  is  any  amount  determined 
by  the  proprietor,  and  the  fact  that  none  of  it  is  payable 
if  no  profits  are  earned  is  evidence  that  it  is  not  really 
salary — but  is  a  withdrawal  of  profits. 

21.  Items  Not  Disclosed 

A  statement  of  cash  receipts  and  payments  will  not 
disclose  changes  in  inventory.  A  statement  of  cash  re- 
ceipts and  payments  does  not  disclose  depreciation 
charges.  Depreciation  continues  regardless  of  the 
amount  of  repairs  and  renewals  or  up-keep  which  may 
or  may  not  have  been  paid  for  in  cash,  and  the  amount 
thereof  should  be  taken  up  in  the  accounts  to  ascertain 
the  total  business  expenses. 

22.  Conclusion 

The  conclusion  is  inevitable  that  the  inflow  and  out- 
flow of  cash  does  not  measure  the  profit  or  loss  of  a  busi- 
ness. It  does  not  take  into  consideration  income  not 
collected  and  expenses  not  paid;  it  omits  certain  items 
such  as  inventory  fluctuations,  which  very  positively 
affect  the  earnings  of  the  business.  A  statement  of  cash 
receipts  and  payments  would  approximate  the  profit  or 
loss  of  a  business  run  strictly  upon  a  cash  basis  if  the 
inventory  remained  constant  and  if  there  were  no  sub- 


CASH    STATEMENTS  115 

stantial  depreciation.     However,   this   combination   of 
circumstances  is  exceedingly  rare. 

A  cash  statement  is  of  value  in  enabling  administra- 
tive officers  to  form  judgments  as  to  financial  policies. 
The  average  inflow  and  outgo  of  cash  during  previous 
periods  indicates  in  a  general  way  the  amount  of  money 
which  will  be  available  for  current  liabilities  during  suc- 
ceeding periods.  The  essential  point  is,  however,  that 
while  the  cash  statement  has  its  uses,  it  does  not  disclose 
the  profit  or  loss  of  a  business.  The  use  of  cash  state- 
ments for  that  purpose  is  now  confined  chiefly  to  clubs, 
churches,  fraternal  societies,  and  very  small  businesses, 
although  until  recently  insurance  companies  made  such 
use  of  them  and  until  more  recently  cities  and  other  gov- 
ernmental bodies  did  likewise. 


REVIEW    QUESTIONS 

1.  Define  expense,  disbursement,  expenditure,  payment. 

2.  Differentiate  between  a  statement  of  income  and  expense  and 

a  statement  of  receipts  and  payments. 

3.  When,  if  ever,  does  a  statement  of  receipts  and  payments  contain 

the  same  information  as  a  statement  of  income  and  expense? 
Discuss  fully. 

4.  What  administrative  value  has  a  statement  of  cash  receipts  and 

payments  ? 


CHAPTER  XI 
THE  BALANCE  SHEET 

1.      Definition  and  Purpose 

A  balance  sheet  is  a  statement  of  assets,  liabilities, 
and  capital  (or  deficit)  as  of  a  specified  moment  of  time, 
prepared  from  double-entry  accounts.  Where  the  ac- 
counts have  not  been  kept  by  double  entry,  the  term 
"balance  sheet"  ought  not  to  be  applied  to  a  statement 
of  financial  condition  because  a  balance  or  equilibrium 
of  the  accounts  does  not  exist.  In  the  latter  case,  the 
statement  should  be  so  entitled  as  to  indicate  the  fact 
that  it  is  not  based  on  double-entry  accounts.  It  may  be 
termed,  for  example,  a  "statement  of  financial  condi- 
tion" or  a  "statement  of  assets,  liabilities,  and  capital." 

The  purpose  of  the  balance  sheet  is  to  display  the 
financial  condition  of  the  business  at  the  time  specified, 
so  that  the  relation  between  current  assets  and  current 
liabilities  and  between  fixed  assets  and  fixed  liabilities 
will  be  apparent.  The  balance  sheet  is  one  of  the  two 
fundamental  accounting  statements  and  it  meets  the  first 
requirement  of  account-keeping,  namely,  that  the  finan- 
cial condition  of  the  business  be  disclosed.  The  other 
fundamental  statement  is  that  showing  the  profit  or  loss 
and  accounting  for  changes  in  financial  condition  (exclu- 
sive of  those  due  to  additions  or  withdrawals  of  capital) . 
Other  statements  are  frequently  used  but  it  will  be 
found  in  almost  every  case  that  they  merely  support  or 
explain  figures  in  the  two  fundamental  statements. 

116 


THE  BALANCE  SHEET  117 

2.     Two  Forms  of  Arrangement 

A  balance  sheet  may  be  arranged  either  in  statement 
form,  with  the  assets  appearing  first,  followed  by  the 
liabilities  and  capital;  or  in  account  form,  with  the 
assets  on  the  left  and  the  liabilities  and  capital  on  the 
right  side.  Although  the  arrangement  of  assets  and 
liabilities  on  opposite  sides  of  the  balance  sheet  may 
be  designated  as  the  "account  form,"  it  is  not  correct 
to  speak  of  the  left  or  asset  side  as  the  "debit  side,"  and 
the  right  or  liability  side  as  the  "credit  side."  A  balance 
sheet  has  neither  debit  nor  credit  side.  It  is  simply  a 
statement  of  the  assets,  liabilities,  and  capital  of  a 
business  at  a  particular  moment  of  time,  and  its 
arrangement  may  vary  according  to  the  ideas  of  the 
compiler. 

When  the  number  of  items  are  few,  it  is  advisable 
to  use  the  statement  form,  so  that  the  entire  balance 
sheet  may  be  shown  on  a  sheet  of  paper,  say,  8%  inches 
wide.  The  account  form  of  a  balance  sheet  requires 
paper  twice  as  wide  as  the  statement  form. 

Assets  and  liabilities  should  be  so  arranged  as  to 
convey  the  clearest  and  fullest  meaning  possible  and 
this  can  usually  be  best  accomplished  by  employing  one 
of  the  two  forms  of  arrangement  shown  below.  While 
both  methods  are  in  common  use,  the  second  form 
should  be  employed  when  compiling  a  statement 
of  financial  condition  for  credit  purposes.  For  such 
purposes,  the  quick,  or  liquid  assets  (those  most 
readily  convertible  into  cash)  are  usually  more  sig- 
nificant than  the  fixed  assets  (those  not  readily  con- 
vertible into  cash  and  the  value  of  which  does  not 
fluctuate  on  account  of  business  operations).    A  credit 


118 


THE  LEDGER 


man  when  estimating"  the  risk  involved  in  an  application 
for  credit  will  often  disregard  the  fixed  assets  while 
carefully  scrutinizing  the  amounts  of  all  quick  assets 
and  quick  liabilities,  and  also  the  difference  between 
their  total  amounts.  This  examination  is  made  to  ascer- 
tain the  amount  of  available  or  working  capital,  which 
may  be  defined  as  the  excess  of  current  assets  over  cur- 
rent liabilities. 


3.     Arrangement  No.  1 

BALANCE  SHEET 
December  81,  1919 


Assets 
Show  all  tangible  fixed  assets  in 

the  order  of  the  size  of  their 

amounts. 
Show  all  intangible  fixed  assets, 

in  the  order  stated  above. 
Show  all  quick  assets  in  the  order 

of  their  availability  to  a  going 

business. 
Show     all     items     of     deferred 

charges  to  profit  and  loss  in  the 

order    of    their    amounts,    the 

largest    amount    being    shown 

first. 


Liabilities  and  Capital 
Show   all   fixed  liabilities   in   the 
order     of    the     size    of    their 
amounts. 
Show  all  current  liabilities  in  the 
order  in  which  they  are  ordi- 
narily liquidated. 
Show  capital  in  proper  detail. 


4.      Arrangement    No.   2 

BALANCE  SHEET 

December  31,  1919 

Assets 

1.  Show  all  quick  assets  in  the  order  of  their  availability  to  a  going 

business. 

2.  Show  all  tangible  fixed  assets  in  the  order  of  their  money  values, 

the  largest  amounts  appearing  first. 

3.  Show  all  intangible  fixed  assets,  in  the  order  stated  above. 


THE  BALANCE  SHEET  119 

4.  Show  all  items  of  deferred  charges  to  profit  and  loss  in  the  order 

of  their  amounts. 

Liabilities  and  Capital 

1.  Show  all  current  liabilities  in  the  order  of  their  liquidation,  with 

the  most  pressing  items  shown  first. 

2.  Show  all  fixed   liabilities   according  to   their   importance,   and 

monetary  size;  or  in  the  order  of  their  permanency. 

3.  Show  capital  in  proper  detail. 

5.  Deferred  Charges  to  Profit  and  Loss 

This  is  a  general  term  which  covers  any  expense 
charged  but  not  absorbed  by  the  operations  of  the  busi- 
ness during  the  present  fiscal  period,  e.g.,  insurance 
premiums  paid  in  advance,  interest  paid  in  advance,  ad- 
vertising paid  in  advance,  or  office  supplies  not  ex- 
hausted. 

6.  Showing  of  Deficit 

Deficit,  if  it  exists,  may  be  shown  in  the  same 
position  on  the  balance  sheet  as  capital,  but  as  a  red 
ink  figure,  in  which  case  it  should  be  deducted  from 
the  total  amount  of  liabilities  in  order  to  bring  the  foot- 
ings of  the  two  sides,  or  parts,  of  the  balance  sheet  in 
agreement.  Deficit  is  sometimes  placed  on  the  asset  side 
of  the  balance  sheet,  but  although  shown  in  this  position 
it  is  obviously  not  an  asset. 

7.  Showing   of  Liabilities 

The  word  "Liabilities"  is  frequently  shown  as  a 
heading  on  the  right-hand  side  of  the  balance  sheet. 
This  would  be  quite  proper  if  all  the  items  on  the  right- 
hand  side  were  liabilities,  but  this  is  not  the  case.    Capi- 


120  THE  LEDGER 

tal,  as  already  explained,  is  the  excess  of  assets  over 
liabilities,  and  is  included  on  the  liability  side  of  the 
balance  sheet  so  as  to  make  the  footing  of  that  side  agree 
with  the  footing  of  the  asset  side.  Thus  a  more  exact 
heading  is  "Liabilities  and  Capital." 

8.  The  Nature  of  Capital 

Capital,  whether  the  business  be  that  of  a  corpora- 
tion, partnership,  or  individual,  is  an  accountability  rest- 
ing upon  or  assumed  by  the  business,  and  the  business 
becomes  custodian  of  the  capital  thus  invested.  It  is  not 
a  liability,  because  the  business  is  not  obliged  to  pay  it  at 
any  time.  Those  who  invest  the  capital  cannot  de- 
mand that  it  be  returned  to  them  as  they  could  in 
the  case  of  an  ordinary  liability  before  the  liquidation 
of  the  business.  In  the  case  of  liquidation  all  creditors 
must  first  be  satisfied  before  the  proprietors  are  allowed 
to  participate  in  the  amount  realized  by  the  assets. 
After  all  liabilities  are  satisfied,  the  residue  belongs  to 
the  proprietors. 

9.  Contingent  Liabilities 

Contingent  liabilities  are  amounts  which  will  become 
payable  by  the  business  only  in  case  certain  contingen- 
cies materialize,  e.g.,  notes  receivable  discounted  (see 
Chapter  XXVII),  accommodation  indorsements,  etc. 
Such  liabilities  should  be  clearly  shown  on  the  balance 
sheet  by  means  of  footnotes  in  which  their  nature  is 
briefly  described,  or  by  other  equally  clear  means  to  be 
described  later.  If  such  liabilities  are  not  shown  on  the 
balance  sheet  they  might  be  overlooked  and  in  that  event 
the  business  might  not  be  prepared  to  meet  them. 


THE  BALANCE  SHEET  121 

10.      Incorrect   Form  of  a  Balance  Sheet 

No  hard  and  fast  rules  can  be  laid  down  as  to  the 
arrangement  of  items  in  a  balance  sheet  or  any  other 
financial  statement.  The  opinions  of  competent  ac- 
countants differ  concerning  many  points  of  arrange- 
ment and  technique.  The  suggestions  made  in  this  and 
other  chapters  are  not  intended  to  be  dogmatic  or  arbi- 
trary; their  purpose  rather  is  to  indicate  how  ambigui- 
ties can  be  avoided  and  statements  made  simple  and  in- 
telligible.   . 

Since  much  can  be  learned  by  the  study  of  a  form 
which  is  faulty  and  the  comparison  of  it  with  a  correct 
form,  two  balance  sheets  are  presented  in  this  chapter — 
the  first  to  illustrate  a  number  of  errors  and  the  second 
to  "how  the  statement  in  its  corrected  form.  A  criticism 
of  the  incorrect  balance  sheet  point  by  point  will  be 
helpful. 

A.  JENKINS 

BALANCE  SHEET 

For  Year  Ended  December  81,  1919 

Assets 

Notes  Receivable $      750.00 

Real  Estate $30,000.00 

Less    Mortgage 14,000.00  16,000.00 

Cash    7,436.00 

Factory  Buildings 22,000.00 

Accounts  Receivable 16,478.00 

Machinery  and  Tools 4,500.00 

Inventory  (at  133  1/3%  of  cost) 8,920.00 

•  $76,084.00 


122  THE  LEDGER 

Liabilities 

Accounts  Payable $28,639.00 

Notes  Payable 16,000.00 

A.   Jenkins,   Capital 31,445.00 


$76,084.00 


11.  Date  of  Balance  Sheet 

The  date  of  this  balance  sheet  is  stated  "for  the  year 
ended  December  31,  1919."  This  is  incorrect  because  a 
balance  sheet  is  a  statement  of  assets,  liabilities,  and 
capital  (or  deficit)  at  some  specified  date,  showing  the 
condition  of  a  business  at  a  particular  moment  of  time, 
that  is,  at  the  close  of  business  on  a  particular  day.  If 
the  condition  as  at  the  close  of  business  on  December 
31,  1919,  is  to  be  stated,  the  balance  sheet  should  be 
dated  "December  31,  1919,"  and  not  in  such  a  way  as 
to  imply  that  the  condition  stated  prevailed  during  a 
period  of  time  such  as  "for  the  year  ended." 

12.  Arrangement    of    Items 

•  Balance  sheets,  in  common  with  all  other  financial 
statements,  should  be  prepared  in  an  orderly  way.  The 
items  should  be  arranged  in  some  logical  order  so  that 
they  can  be  easily  read  and  understood.  Both  assets 
and  liabilities  on  this  balance  sheet  are  listed  indiscrim- 
inately. Accounting  authorities  are  not  in  agreement 
as  to  the  order  to  be  followed,  but  all  agree  that  some 
definite  order  should  be  maintained  in  the  listing  of  both 
assets  and  liabilities.  One  plan  is  to  list  them  in  the 
order  of  time  in  which  they  will  probably  be  converted 
into  cash  or  paid;  another  plan  is  to  adopt  exactly  the 


THE  BALANCE  SHEET  123 

reverse  arrangement.  In  practice  the  plan  which  will 
arrange  the  items  in  their  order  of  interest  to  the  user 
of  the  statement  is  the  one  to  be  adopted. 

Generally  speaking,  a  balance  sheet  of  a  sole  pro- 
prietor should  list  the  assets  and  liabilities  in  the  first 
order  named.  This  is  because  the  items  of  most  interest 
are  the  current  assets  and  liabilities  or  those  which  are 
actively  handled  by  the  business.  In  the  corrected 
balance  sheet  given  in  §  17,  the  assets  and  liabilities 
are  listed  with  the  current  items  first  in  the  probable 
order  of  their  conversion  into  cash  or  liquidation  by 
payment. 

13.     Inventory  Valuation 

In  the  foregoing  balance  sheet  the  inventory  is 
shown  valued  at  133  1/3%  of  cost,  which  represents  its 
estimated  selling  price,  the  gross  profit  of  33  1/3% 
having  been  calculated  on  cost.  It  is  incorrect  to  carry 
an  inventory  at  valuation  exceeding  its  cost  for  the  fol- 
lowing reasons :  There  can  be  no  profit  on  merchandise 
until  it  has  been  sold  and  yet,  if  merchandise  is  carried 
as  an  asset  at  more  than  its  cost,  the  effect  is  to  show 
that  a  profit  has  already  been  earned.  This  follows 
from  the  fact  that  if  the  asset  "inventory"  is  increased 
above  its  cost,  some  other  account  must  be  credited  with 
that  increase,  and  since  no  liability  account  is  affected 
the  increase  must  be  credited  as  a  profit.  The  item  of 
inventory  ought,  therefore,  to  be  reduced  to  100%  of 
cost.  133  1/3%  equals  4/3,  and  since  4/3  amounts  to 
$8,920,  1/3  will  equal  %  of  this  amount,  or  $2,230,  and 
3/3,  or  100%  of  the  cost,  will  be  three  times  this  amount, 
or  $6,690.    The  latter  amount  is  the  proper  valuation. 


IM  THE  LEDGER 

14.     Working  Capital 

The  current  assets  as  shown  by  the  revised  balance 
sheet  consist  of: 

Cash    $  7,436.00 

Notes    Receivable 750.00 

Accounts  Receivable 16,478.00 

Inventory   6,690.00 

$31,354.00 

The  current  liabilities  on  the  other  hand  are: 

Notes  Payable $16,000.00 

Accounts  Payable 28,639.00 

$44,639.00 


It  thus  appears  that  the  current  assets  would  be  in- 
sufficient to  meet  the  current  liabilities  by  $13,285. 

Under  these  circumstances  the  business  cannot 
be  said  to  have  any  working  capital.  Working 
capital  should  be  clearly  indicated  on  a  balance  sheet 
and  this  can  be  done  only  by  grouping  the  items  so  that 
current  assets  can  be  compared  with  current  liabilities. 

i 
15.      Real  Estate  Mortgage 

In  the  balance  sheet  as  given,  the  real  estate  mort- 
gage is  deducted  from  the  Real  Estate  account,  only 
the  equity  in  the  property  being  carried  as  an  asset. 
Many  accounting  authorities  approve  of  this  procedure ; 
some  of  them  in  all  cases,  and  others  only  if  the  property 
when  acquired  is  subject  to  a  mortgage  without  assump- 
tion of  the  mortgage  debt  by  the  present  owner.  This 
view  is  logical  and  if  the  mortgage  on  the  real  estate  is 


THE  BALANCE  SHEET  125 

purely  a  right  against  the  property  and  if  there  is  no 
personal  liability  on  the  mortgage  debt,  the  deduction 
of  the  mortgage  from  the  real  estate  serves  the  useful 
purpose  of  indicating  the  present  value  of  the  equity. 

However,  even  on  the  assumption  that  there  is  no 
present  liability  on  the  mortgage,  if  the  real  estate  was 
acquired  for  a  fixed  asset,  it  is  unlikely  that  the  present 
owner  would  permit  the  mortgagee  to  foreclose.  Con- 
sequently, it  seems  better  to  list  the  real  estate  at  its 
cost  plus  the  mortgage  debt,  and  to  include  the  mort- 
gage among  the  liabilities,  even  though  the  mortgage 
debt  may  not  have  been  incurred  by  the  present  owner 
or  assumed  by  him. 

16.      Facts  versus  Opinion 

Many  statements  in  the  balance  sheet  under  discus- 
sion are  assumed  to  be  matters  of  fact,  whereas  they  are, 
in  reality,  matters  of  opinion.  The  assets,  cash  and 
notes  receivable,  may  fairly  be  said  to  be  statements  of 
fact  in  that  there  is  a  balance  in  the  bank  and  currency 
in  the  office  which  equal  the  asset  of  cash  and  definite 
notes  equal  to  the  amount  carried  in  the  balance  sheet 
for  notes  receivable.  On  the  other  hand,  certain  of  the 
assets  are  given  an  estimated  value;  machinery  and 
tools,  buildings,  even  real  estate  itself,  are  really  listed 
at  figures  which  represent  only  opinion  as  to  their  worth. 
Moreover,  the  amount  at  which  accounts  receivable  are 
carried  is  purely  a  matter  of  opinion  because  there  is  no 
way  of  knowing  whether  or  not  they  are  actually  worth 
the  figure  given.  That  figure  may  include  actual  losses 
already  incurred  from  bad  debts. 

On  the  liability  side  accounts  payable  and  notes  pay- 


126  THE  LEDGER 

able  are  statements  of  fact.  The  amount  of  capital  is 
largely  a  matter  of  opinion  because  the  profits  or  losses 
which  have  changed  it  from  its  original  amount  are 
based  on  estimates  both  as  to  income  and  possible  losses. 

17.      Corrected   Balance  Sheet 

After  the  various  changes  explained  above  are  made, 
the  balance  sheet  would  appear  in  the  following  form: 

A.  JENKINS 

BALANCE   SHEET 

December  81,  1919 

Assets 

Current  Assets : 

Cash    $  7,436.00 

Notes  Receivable 750.00 

Accounts  Receivable 16,478.00 

Inventory    6,690.00  $31,354.00 

Fixed  Assets: 

Machinery  and  Tools $  4,500.00 

Factory  Buildings 22,000.00 

Real  Estate 30,000.00  56,500.00 

$87,854.00 
Liabilities  and  Capital  * 

Current  Liabilities: 

Notes  Payable $16,000.00 

Accounts   Payable 28,639.00  $44,639.00 

Fixed  Liabilities: 

Real  Estate  Mortgage 14,000.00 

Capital   29,215.00 

$87,854.00 


(' 


THE  BALANCE  SHEET  127 

18.     Balance  Sheet  and  Post-Closing  Trial  Balance 

As  explained  in  Chapter  VII,  a  trial  balance  is 
taken  off"  prior  to  making  the  adjusting  and  closing 
entries  necessary  for  the  determination  of  the  profit  or 
loss  of  the  business.  Such  entries  eliminate  the  nomi- 
nal accounts  by  transferring  their  balances  to  the  Capi- 
tal account  via  the  Profit  and  Loss  account.  After  that 
elimination  has  been  accomplished,  only  real  and  per- 
sonal accounts  remain  open  upon  the  ledger.  At  that 
point  another  trial  balance  should  be  taken  in  order  to 
ascertain  that  no  clerical  errors  were  made  in  the  process 
of  "closing"  the  accounts.  The  new  trial  balance  is 
known  as  the  post-closing  trial  balance  because  it  is 
made  after  the  closing  of  the  nominal  accounts. 

The  post-closing  trial  balance  obviously  can  disclose 
only  assets,  liabilities,  and  capital  because  only  real  and 
personal  accounts  remain  open  on  the  ledger.  This 
trial  balance,  however,  usually  does  not  obviate  the  prep- 
aration of  a  balance  sheet  for  the  following  reasons : 

(a)  The  trial  balance  lists  the  accounts  in  the  order 

in  which  they  are  found  on  the  ledger,  and 
this  order  is  not  generally  the  one  best 
adapted  for  presentation  of  the  items  in  a 
balance  sheet. 

(b)  The  trial  balance  does  not  show  group-  or  sub- 

totals for  current  assets,  fixed  assets,  current 
liabilities,  and  the  like;  such  sub-totals  are 
essential  in  the  balance  sheet  in  order  to 
facilitate  the  determination  of  working  capi- 
tal and  other  vital  facts. 

(c)  The  trial  balance  states  each  balance  as  debit 

or  credit,  whereas  in  the  balance  sheet  it 


128  THE  LEDGER 

sometimes  is  desirable  to  deduct  certain 
debit  balances  from  credit  balances,  or  vice 
versa,  in  order  to  show  clearly  the  most  sig- 
nificant figures. 

Thus,  although  the  post-closing  trial  balance  con- 
tains all  the  figures  needed  for  a  balance  sheet,  the  latter 
statement  should  be  prepared  to  present  these  figures  in 
the  form  designed  to  be  most  intelligible  to  the  persons 
who  require  the  information  to  be  conveyed. 


REVIEW  QUESTIONS 

1.  What  is  a  balance  sheet? 

2.  In  what  order  should  the  several  items  in  a  balance  sheet  be 

placed?     Give  reasons. 

3.  What  are  the  principal  differences  between  a  trial  balance  taken 

before  the  books  are  closed  and  one  taken  directly  after  they 
are  closed  ?    How  does  the  latter  differ  from  a  balance  sheet  ? 

4.  Is  the  trial  balance  essential  to  the  making  of  the  balance  sheet, 

and  if  so,  why?     And  if  not,  why  not? 

5.  Distinguish  between  the  function  of  a  profit  and  loss  statement 

and  that  of  a  balance  sheet. 


CHAPTER   XII 
STATEMENT  OF  AFFAIRS 

1.  Balance  Sheet  Information 

The  successful  administration  of  any  business  requires 
two  kinds  of  information — one  concerning  the  profits 
and  losses  made  during  a  period  of  time  and  the  other 
showing  the  financial  condition  at  a  particular  moment 
of  time.  This  chapter  is  concerned  with  the  latter  kind 
of  information  when  a  business  is  about  to  dissolve  or  to 
pass  through  either  voluntary  or  involuntary  reorgani- 
zation. 

The  financial  condition  of  a  solvent,  going  concern 
is  shown  in  the  balance  sheet  as  described  in  Chapter  XI. 
Therein  the  fixed  assets  are  valued  at  cost  less  a  reason- 
able depreciation  regardless  of  their  present  market 
price,  and  inventories  of  merchandise  are  valued  at  cost 
or  market  price,  whichever  is  lower.  The  liabilities  are 
listed  on  a  balance  sheet  at  their  full  amounts  regardless 
of  any  securities  held  by  individual  creditors  or  of  any 
preferences  which  may  entitle  some  creditors  to  priority 
in  payment.  The  balance  sheet  shows  merely  the  total 
assets  and  the  total  liabilities,  not  indicating  in  any  way 
how  such  assets  would  be  applied  to  the  payment  of 
liabilities  in  the  event  of  insolvency. 

2.  Solvency  and   Insolvency 

The  term  "insolvency"  is  sometimes  used  vaguely, 
without  a  clear  comprehension  of  its  meaning.  The  word 

129 


130  THE  LEDGER 

must  be  defined  in  order  to  understand  the  exact  function 
of  statements  prepared  to  show  the  degree  of  insolvency. 
The  assets  of  a  business  may  exceed  its  liabilities  and 
yet  it  may  be  unable  to  pay  its  creditors  promptly. 
Ready  money  may  have  been  invested  in  fixed  assets 
in  such  amounts  that  the  current  liabilities  cannot  be  met 
as  they  mature.  From  one  point  of  view  such  a  business 
is  regarded  as  insolvent.  A  business  may  be  insolvent 
also  from  another  viewpoint.  It  may  be  able  to  pay  its 
current  obligations  for  the  present  and,  with  reasonable 
certainty,  for  the  immediate  future,  and  yet  the  fact 
may  be  obvious  that  within  a  short  time  it  will  become 
unable  to  do  so  because  its  assets  will  have  been 
exhausted.  In  that  case  the  business  is  insolvent  because 
its  liabilities  exceed  its  assets  although  it  is  able  for  the 
present  to  meet  current  obligations. 

3.     Inadequacy  of  Balance  Sheet  for  Insolvents 

In  either  case,  when  a  business  is  insolvent  it  becomes 
necessary  to  secure  more  capital,  to  reorganize  by  a 
change  of  personnel,  or  to  dissolve  entirely.  Whatever 
the  remedy,  the  persons  vitally  interested  are  the  credi- 
tors and  the  proprietors.  The  financial  condition  of  the 
business  must  be  so  displayed  that  both  sets  of  persons 
interested  can  clearly  see  what  the  outcome  of  the  reor- 
ganization or  the  dissolution  is  likely  to  be.  Of  the  two, 
the  creditors  are  to  be  considered  first  because  under  the 
law  no  proprietor  is  entitled  to  take  precedence  over  any 
creditor  in  the  distribution  of  the  assets  of  an  insolvent 
business. 

A  balance  sheet  falls  short  nf  being  an  adequate  pre- 
sentation of  the  financial  condition  of  an  insolvent  busi- 


STATEMENT  OF  AFFAIRS  131 

ness  for  the  following  reasons.  In  the  first  place  the 
assets  are  not  to  be  continued  in  use  by  the  business  but 
are  to  be  sold  at  whatever  can  be  procured  for  them. 
On  a  forced  sale,  assets  produce  much  less  than  their 
book  value,  at  which  a  going  concern  is  entitled  to  carry 
them.  Thus  a  balance  sheet  will  not  disclose  what  the 
business  may  reasonably  expect  to  realize  on  its  assets. 
In  the  second  place,  a  balance  sheet  does  not  indicate 
whether  or  not  any  of  the  assets  are  held  as  security  by 
any  of  the  creditors,  nor  does  it  indicate  whether  any 
particular  creditors  must  be  paid  before  other  creditors. 

4.      Statement  of  Affairs 

From  the  foregoing  presentation  of  the  inadequacy 
of  a  balance  sheet  when  a  business  is  insolvent  and  is 
about  to  dissolve,  it  becomes  apparent  that  a  special 
form  of  statement  must  be  prepared  to  set  out  the  facts 
of  insolvency.  This,  known  as  a  statement  of  affairs,  is 
so  arranged  as  to  show,  first,  the  assets  at  both  their 
book  value  and  at  the  valuation  which  they  may  reason- 
ably be  expected  to  realize  at  forced  sale;  then,  the 
liabilities  in  the  order  in  which  they  must  be  paid,  if  any 
such  order  exists;  and  finally,  what  part  of  the  assets 
have  legally  been  pledged  to  secure  payment  of  particu- 
lar liabilities,  thus  disclosing  the  net  value  of  assets  esti- 
mated to  be  available  for  the  payment  of  unsecured 
creditors.  The  form  of  such  a  statement  is  immaterial 
provided  it  discloses  the  three  kinds  of  information  enu- 
merated. It  will  be  found  in  practice,  however,  that 
the  form  suggested  in  §  9  conveniently  meets  these  con- 
ditions and  therefore  should  be  adopted  in  ordinary  cases 
of  insolvency. 


\m  THE  LEDGER 

5.     Rules  for  Valuing  and  Stating  Assets 

Assets  should  be  shown  in  a  statement  of  affairs  in 
some  logical  arrangement,  preference  being  given  to  a 
listing  of  current  assets  first.  Three  money  columns 
should  be  used.  In  the  first  of  these  the  book  values 
at  which  the  assets  have  been  carried  on  the  accounts  of 
the  business  should  be  shown;  in  the  second  column 
should  be  indicated  the  probable  amounts  to  be  realized 
upon  the  forced  sale  of  such  assets;  and  in  the  third, 
the  differences  between  the  book  values  and  such  anti- 
cipated amounts.  As  a  general  rule,  a  substantial 
shrinkage  in  asset  value  may  be  expected.  The  amount 
of  this  shrinkage  constitutes  that  part  of  the  deficit 
due  to  the  loss  in  asset  value  upon  forced  sale. 

To  estimate  the  amount  that  may  be  realized  upon 
a  forced  sale  is  a  difficult  problem.  The  amount  must 
be  fixed  with  two  considerations  in  view.  It  must  not 
be  overstated  because  that  would  lead  to  unwarranted 
expectations  on  the  part  of  creditors  who  might  rely 
upon  such  a  statement  in  effecting  a  settlement  of  their 
claims  with  the  business.  On  the  other  hand,  it  must 
not  be  understated  because  that  would  tend  to  relieve  the 
person  who  conducts  the  sale  from  the  obligation  to 
secure  the  highest  possible  price.  The  liquidator  should 
be  spurred  on  to  secure  the  highest  possible  price  and 
he  should  not  be  given  any  excuse  for  selling  at  a  lower 
price. 

The  reason  for  stating  the  book  value  of  the  assets 
is  to  provide  a  means  of  checking  or  comparing  the 
statement  of  affairs  with  the  balance  sheet  in  order  to 
determine  that  all  the  assets  have  been  listed.  If  their 
total  book  value  as  shown  by  the  statement  of  affairs 


STATEMENT  OF  AFFAIRS  133 

agrees  with  the  total  as  indicated  on  the  balance  sheet, 
a  ready  verification  of  the  former  statement  can  be 
made. 

6.      Rules  for  Stating  Liabilities 

The  liabilities  should  be  listed  in  the  same  general 
order  used  in  the  stating  of  assets,  and  for  each  liability 
should  be  noted  both  its  book  value  and  the  amount 
which  will  have  to  be  paid  from  the  general  assets  of  the 
business. 

Those  liabilities  which  are  secured  will  not  be  paid 
out  of  the  general  assets.  A  secured  liability  is  one  for 
which  the  creditor  holds  assets  of  the  business  previously 
given  to  him  in  accordance  with  law  as  security  for  his 
claim,  which  assets  are  salable  by  him  under  conditions 
of  law  in  case  the  business  fails  to  meet  the  liability. 
Secured  creditors  naturally  will  utilize  for  their  reim- 
bursement such  assets  as  they  hold  as  security.  Conse- 
quently secured  liabilities  are  noted  in  the  first  column 
of  the  statement  of  affairs  as  being  book  liabilities; 
but  their  amounts  are  not  extended  into  the  second 
column  because  they  do  not  constitute  claims  to  be  met 
out  of  the  general  assets. 

In  the  same  way  liabilities  entitled  to  preference, 
such  as  those  for  wages  and  taxes,  should  be  listed  as 
book  liabilities  but  not  stated  in  the  "Expected  to  Rank" 
column.  Their  amounts  should  be  deducted  from  the 
total  assets  in  order  to  express  in  the  statement  the  fact 
that  the  first  available  assets  will  be  utilized  in  the  pay- 
ment of  such  preferred  claims.  Attention  is  called  to 
the  handling  of  these  items  in  the  example  of  a  state- 
ment of  affairs  given  below. 


134  THE  LEDGER 

7.      Example  of  a  Balance  Sheet 

In  the  following  balance  sheet  the  current  assets  are 
insufficient  by  $16,531  to  meet  the  current  liabilities. 
The  current  assets  consisting  of  cash  and  other  items 
which  in  the  ordinary  course  of  business  will  be  con- 
verted into  cash  amount  to  $28,108,  whereas  the  current 
liabilities  are  $44,639. 

This  balance  sheet  thus  presents  one  condition  of 
insolvency,  namely,  the  inability  to  meet  current  lia- 
bilities as  they  mature.  Assuming  that  the  business  of 
the  Jenkins  Company  is  to  be  reorganized  and  new 
capital  procured,  the  first  step  should  be  the  preparation 
of  a  statement  of  affairs  of  the  company.  The  balance 
sheet  shown  below  will  be  converted  into  such  a  state- 
ment. 

THE  JENKINS  COMPANY 

BALANCE  SHEET 

December  81,  1919 

Assets 
Fixed  Assets: 

Real  Estate  $30,000.00 

Factory  Buildings  $22,000.00 

Less  Reserve  for  Depreciation 2,000.00      20.000.00 

Machinery  and  Tools  $  4,500.00 

Less  Reserve  for  Depreciation 900.00        3,600.00    $53,(500.00 

Current  Assets: 

Inventory   $  6,690.00 

Accounts  Receivable $16,478.00 

Less  Reserve  for  Bad  Debts 3,246.00      13,232.00 

Notes  Receivable  750.00 

Cash   7,436.00      28,108.00 

Total  Assets  $81,708.00 


STATEMENT  OF  AFFAIRS  135 

Liabilities 

Fixed  Liabilities  and  Capital: 

Capital  Stock  Issued   $32,000.00 

Less  Treasury  Stock    18,000.00 

Capital  Stock  Outstanding $14,000.00 

Real  Estate  Mortgage  14,000.00    $28,000.00 

Current  Liabilities: 

Accounts  Payable   $28,639.00 

Notes  Payable 16,000.00       44,639.00 

Surplus: 

Surplus   Available    for   Dividends $4,069.00 

Reserve  for  Additions  and  P^xtensions  of  Plant..         5,000.00         9,069.00 

Total  Liabilities $81,708.00 


8.      Information  Required  for  Statement  of  Affairs 

In  order  to  prepare  a  statement  of  affairs  from  the 
above  balance  sheet  certain  information  not  disclosed 
therein  is  needed.  One  must  ascertain  the  realizable 
value  of  the  assets;  which  of  them,  if  any,  have  been 
pledged  to  creditors;  and  what  liabilities,  if  any,  are 
preferred.  Assume  that  the  following  facts  are  to  be 
taken  into  consideration.  The  real  estate  and  buildings 
which  are  covered  by  the  mortgage  are  estimated  to  be 
worth  just  enough  to  satisfy  the  mortgage  debt.  The 
machinery  and  tools  are  appraised  to  produce  $2,500. 
The  inventory  is  estimated  at  $4,000,  and  the  accounts 
receivable  are  grouped  into  three  classes  as  follows: 
good  accounts  $8,000,  doubtful  accounts  $2,000,  and  the 
balance  worthless.  The  doubtful  accounts  are  estimated 
to  be  worth  50  per  cent.  The  notes  receivable  are  con- 
sidered good  but  the  cash  balance  includes  personal 
I.  O.  U.'s  of  $250  which  are  not  expected  to  be  collecti- 


136  THE  LEDGER 

ble.  The  accounts  payable  include  an  accrued  pay-roll 
of  $450  and  taxes  of  $1,600.  One  of  the  notes  payable 
for  $5,000  is  secured  by  an  assignment  of  $6,000  of  good 
accounts  receivable. 

9.      Example  of  Statement  of   Affairs 

With  this  information  as  a  guide  the  balance  sheet 
may  now  be  converted  into  a  statement  of  affairs.  Such 
a  statement  is  here  shown  and  the  comments  which  fol- 
low explain  the  steps  by  which  it  has  been  prepared. 

THE  JENKINS  COMPANY 

STATEMENT  OF  AFFAIRS 

December  81,  1919 

Assets 
Book  Expected  to 

Value  Realize 

Real  Estate  $30,000.00 

Factory  Buildings   22,000.00 

Total    $52,000.00 

Deduct — Reserve     for     De- 
preciation          2,000.00 

$50,000.00         Book  Value  $50,000.00 

Deduct— Mortgage,   contra.      14,000.00  $36,000.00 

3,600.00    Machinery  and  Tools $2,500.00         1,100.00 

6,690.00     Inventory    4,000.00         2,690.00 

8,000.00    Accounts  Receivable  Good...   $  8,000.00 

Deduct— Loan,    contra 5,000.00  3,000.00 

2,000.00    Accounts  Receivable  Doubtful 1,000.00         1,000.00 

Accounts    Receivable    Worth- 
less      $  6,478.00 

Deduct — Reserve    for    Bad 
3,232.00  Debts  3,246,00  3,232.00 


STATEMENT  OF  AFFAIRS  137 

Book  Expected  to  _  «  . 

,.  ,  o    ,.        Deficiency 

Value  Realize  ' 

750.00    Notes    Receivable    750.00 

7,436.00    Cash    7,186.00  250.00 


$81,708.00     ....Total  per  contra.  $44,272.00 

Total  Amount  Expected  to  Realize. . .     $18,436.00 

Deduct — Preferred  Claims,  contra: 

Wages    $      450.00 

Taxes  1,600.00        2,050.00 

Net  free  assets  available  for  dividend 
of  approximately  43%  to  unsecured 
creditors    $16,386.00 

Deficiency     21,203.00 

Unsecured  Creditors,  contra   $37,589.00 


Liabilities 

Book  Expected  to 

Value  Rank 

$14,000.00    Real  Estate  Mortgage,  deducted  contra. 

26,589.00    Accounts   Payable   $26,589.00 

16,000.00   Notes  Payable $16,000.00 

Deduct — Note  Secured,  per 

contra 5,000.00       11,000.00 

450.00    Wages  Payable,  deducted  contra. 
1,600.00    Taxes  Payable,  deducted  contra. 

$58,639.00  Total    $37,589.00 

Capital  Obligations. - 
14,000.00        Capital  Stock 
9,069.00        Surplus 

$81,708.00    . . .  .Total  per  contra. 


10.      Comments   on   Statement   of   Affairs 

The  totals  of  the  book  value  columns  are  equal  and 
agree  with  the  totals  shown  in  the  balance  sheet.    This 


138  THE  LEDGER 

agreement  is  secured  as  regards  the  liabilities  by  in- 
cluding the  capital  obligations,  although  of  course 
they  will  not  rank  as  liabilities.  It  is  desirable  to  have 
these  columns  in  agreement  with  the  balance  sheet  fig- 
ures to  indicate  that  no  assets  or  liabilities  have  been 
overlooked  in  the  preparation  of  the  statement. 

The  reserves  for  depreciation  and  bad  debts  have 
been  deducted  from  the  values  of  the  assets  as  they 
appear  in  the  ledger  in  order  to  determine  the  book 
values  at  which  they  are  listed  on  the  statement.  This  is 
advisable  because  the  reserve  for  depreciation  is  really 
a  suspended  credit  which  could  logically  have  been  made 
in  the  asset  account  but  which  for  bookkeeping  conven- 
ience was  placed  in  a  separate  account.  Such  a  reserve 
account  has  been  called  a  "valuation  account"  because  it 
reduces  the  value  of  the  asset  to  which  it  applies.*  By 
showing  the  real  asset  value  as  the  book  value,  any 
shrinkage  prior  to  realization  upon  the  forced  sale  is 
eliminated  so  that  the  deficiency  as  it  appears  on  the 
statement  of  affairs  represents  the  shrinkage  due  solely 
to  the  forced  sale.  This  deficiency  should  not  be  inflated 
by  stating  the  book  value  as  higher  than  the  company 
itself  considered  the  real  value  of  the  asset  to  be. 

The  liability  on  the  mortgage  of  $14,000  is  deducted 
from  the  real  estate  and  buildings  out  of  which  the 
mortgage  is  to  be  paid.  Thus  the  mortgage  does  not 
appear  in  the  "Expected  to  Rank"  column  of  the 
liabilities;  and  as  the  real  estate  and  buildings  are 
considered  just  sufficient  to  satisfy  the  mortgage,  they 
are  not  listed  in  the  "Expected  to  Realize"  column  of 
the  assets. 

•For  a  complete  discussion  of  the  underlying  theory,   see  Volume  IV. 


STATEMENT  OF  AFFAIRS  139 

The  note  payable  of  $5,000  secured  by  the  pledge 
of  accounts  receivable  is  similarly  treated.  As  accounts 
receivable  to  the  amount  of  $6,000  are  pledged  to  secure 
this  note,  the  total  surplus  of  $3,000  of  "Accounts  Re- 
ceivable Good"  is  entered  in  the  "Expected  to  Realize" 
column. 

The  statement  shows  that  $18,436  is  expected  to  be 
realized  from  all  the  assets  including  those  which  are 
held  as  security  by  creditors.  This  $18,436  must,  how- 
ever, be  reduced  by  the  preferred  claims  consisting  of 
wages  and  taxes,  which  total  $2,050.  Since  these  pre- 
ferred claims  must  be  paid  at  once,  the  cash  available 
for  creditors  will  be  reduced  by  their  amount.  This 
deduction  leaves  $16,386  available  for  unsecured 
creditors  whose  claims  amount  to  $37,589,  as  appears 
from  the  "Expected  to  Rank"  column  of  the  liabilities. 
Each  creditor  may  therefore  expect  to  receive  a  dividend 
of  about  43%  of  his  claim  and  this  information  is  clearly 
disclosed  by  the  statement. 

In  order  to  bring  the  total  of  the  "Expected  to 
Realize"  column  into  agreement  with  that  of  the  "Ex- 
pected to  Rank"  column,  the  deficiency  of  $21,203  is 
entered  under  the  net  free  assets.  This  deficiency  does 
not  agree  with  the  total  of  the  deficiency  column 
of  the  assets  which  is  $44,272.  The  reason  for  this 
lack  of  agreement  is  that  while  there  is  a  real  deficiency 
or  shrinkage  in  asset  value  of  $44,272,  this  shrinkage  is 
not  wholly  borne  by  the  creditors.  The  capital  obliga- 
tions amount  to  $23,069,  consisting  of  the  capital  stock 
and  the  surplus.  As  none  of  the  assets  can  be  applied 
to  the  reimbursement  of  stockholders  until  all  creditors 
have  been  paid,  it  follows  that  the  former  will  receive 


140 


THE  LEDGER 


nothing  because  there  is  not  sufficient  to  pay  the 
creditors.  Therefore  the  stockholders  must  suffer  a  loss 
of  their  entire  investment  of  $23,069.  Their  loss 
together  with  that  of  the  creditors,  namely,  $21,203, 
makes  the  total  deficiency  due  to  shrinkage  in  asset 
value  of  $44,272. 

11.      Deficiency  Account 

It  is  customary  to  supplement  a  statement  of  affairs 
with  a  schedule  showing  how  the  deficiency  has  been 
caused.  Such  a  statement  is  sometimes  given  in  ledger 
account  form.  The  losses  due  to  shrinkage  on  each  asset 
are  listed  on  the  debit  side  and  are  offset  on  the  credit 
side  by  the  capital  obligations,  which  represent  the  losses 
by  stockholders,  and  by  the  deficiency  borne  by  the 
creditors.  In  this  form,  the  deficiency  account  for  the 
above  statement  of  affairs  would  be  as  follows : 


Loss  on  Real  Estate  and 

Buildings    $36,000.00 

Loss    on    Machinery    and 

Tools    1,100.00 

Loss  on  Inventory   2,690.00 

Loss  on  Accounts  Re- 
ceivable        4,232.00 

Loss  on  I.  O.  U.'s 250.00 

Total $44,272.00 


Capital   Stock $14,000.00 

Surplus   9,069.00 

Deficiency  per  Statement 

of  Affairs    21,203.00 

Total $14,272.00 


The  same  information  can  usually  be  displayed  more 
simply  by  listing  the  losses  in  detail  and  then  deducting 
from  the  total  that  part  of  the  loss  to  be  borne  by  the 
stockholders,  namely,  the  amount  of  the  capital  obliga- 
tions.    This  will  leave  as  a  balance  the  amount  to  be 


STATEMENT  OF  AFFAIRS  141 

borne  by  unsecured  creditors — in  the  case  under  discus- 
sion, the  deficiency  of  $21,203. 

The  forms  to  be  selected  for  a  statement  of  affairs 
and  a  deficiency  account  should  be  such  as  are  likely  to 
be  the  most  intelligible  to  the  persons  who  are  to  use 
them.  No  arbitrary  forms  are  required  by  usage  but 
those  given  above  are  frequently  adopted. 


CHAPTER   XIII 

REALIZATION  AND  LIQUIDATION 
STATEMENT 

1.     Duties  of  a  Liquidator 

When  a  business  must  be  dissolved  for  the  benefit 
of  creditors,  it  is  customary  to  appoint  a  receiver, 
assignee,  or  liquidator  for  the  purpose  of  selling  the 
assets,  paying  the  creditors,  and  distributing  any  re- 
maining cash  to  the  former  proprietors.  Such  a 
liquidator  may  be  appointed  by  agreement  between  the 
insolvent  and  the  creditors  in  a  proceeding  known  as  a 
friendly  assignment  for  the  benefit  of  creditors.  The 
liquidator,  on  the  other  hand,  may  be  appointed  by  a 
court  to  which  creditors  have  appealed.  The  liquidator 
in  the  latter  case  is  usually  called  a  receiver  or  a  trustee 
and  the  proceedings  are  usually  known  as  involuntary, 
since  the  insolvent  did  not  voluntarily  enter  into  them. 
Whatever  the  method  of  appointment,  and  whatever  the 
title  of  the  liquidator,  his  duties  are  in  the  main  to  secure 
possession  of  all  assets;  to  reduce  them  to  cash  by  col- 
lection or  sale;  to  apply  the  cash  to  the  payment  of 
creditors,  turning  any  remaining  cash  or  unrealized 
assets  over  to  the  former  proprietors;  and  finally  to 
report  all  his  transactions  to  the  persons  who,  or  to  the 
court  which  appointed  him.  Even  though  the  liquida- 
tion be  under  the  cognizance  of  a  court,  the  preparation 
of  the  liquidator's  final  statement  is  an  accounting  mat- 
ter, requiring  at  times  considerable  technical  skill. 

142 


REALIZATION  AND  LIQUIDATION  STATEMENT    143 

2.  Statements  by  Liquidator 

The  first  statement  which  a  liquidator  should  pre- 
pare is  a  balance  sheet  disclosing  the  condition  of  the 
insolvent  business  as  shown  by  its  books.  The  next  step 
is  to  convert  the  balance  sheet  into  a  statement  of  affairs 
showing  the  probable  outcome  of  the  liquidation,  as  ex- 
plained in  Chapter  XII.  After  the  liquidation  has  been 
completed  the  liquidator  should  prepare  a  report,  the 
conventional  form  for  which,  so  far  as  the  figures  are 
concerned,  is  known  as  a  "Realization  and  Liquidation 
Statement."  This  statement  sometimes  is  called  an 
"account,"  but  it  should  be  borne  in  mind  that  rarely 
is  it  necessary  or  advisable  to  have  one  ledger  account 
to  cover  all  the  transactions  of  the  liquidator.  The 
statement  discussed  in  this  chapter  is  one  prepared  by 
the  liquidator  of  the  Jenkins  Company,  thus  following 
the  same  chain  of  transactions  considered  in  the  preced- 
ing chapter. 

3.  Form  of  Statement 

The  form  of  statement  used  herein  is  the  conven- 
tional one.  While  not  required  by  usage  or  by  law,  it 
is  so  convenient  that  it  should  be  thoroughly  understood. 
The  purposes  of  the  statement  are  to  show  what  assets 
were  received  to  be  realized  and  what  became  of  them; 
what  liabilities  were  to  be  liquidated  and  how  that  was 
accomplished ;  what  the  expenses  of  the  proceeding  have 
been  and  what  was  the  net  outcome. 

4.  Additional  Information  Required 

Since  the  statement  of  realization  and  liquidation  is 
a  report  showing  the  liquidator's  transactions,   it   is 


144  THE  LEDGER 

necessary  to  know  those  transactions  before  the  report 
can  be  prepared. 

For  the  purpose  of  supplying  material  for  this  state- 
ment, the  following  facts  are  assumed.  Upon  fore- 
closure sale  of  the  real  estate  and  buildings  under  the 
mortgage  $17,000  was  realized.  The  machinery  and 
tools  sold  for  $1,000.  The  inventory  was  taken  over 
by  a  creditor  at  a  valuation  of  $3,000.  The  accounts 
receivable  considered  good  produced  the  full  amount, 
those  considered  doubtful  produced  $1,500,  and  on  those 
considered  bad  $240  was  collected.  The  notes  receivable 
were  collected  and  the  cash  was  found  to  be  in  agree- 
ment with  the  books  except  for  the  I.O.U.'s  of  $250 
which  proved  to  be  worthless.  The  liquidator  was 
allowed  $900  to  cover  his  fee  and  the  expenses  of 
liquidation.  He  paid  the  wages  and  taxes  and  a  dividend 
of  35%  to  the  unsecured  creditors  and  then  prepared 
the  realization  and  liquidation  statement. 

5.  Illustrative  Statement 

An  illustrative  realization  and  liquidation  statement 
is  given  on  the  opposite  page. 

6.  Comments    on    Realization    and    Liquidation    State- 

ment 

The  following  comments  should  be  carefully  con- 
sidered in  connection  with  the  statement  itself  so  that 
the  reason  for  the  form  of  presentation  and  the  source 
of  all  the  figures  therein  will  be  clearly  understood. 

The  statement  will  be  found  upon  examination  to 
show  the  profit  and  loss  upon  realization.  It  reveals  a 
gain  of  $340  which  is  a  reduction  of  the  deficiency  of 


REALIZATION  AND  LIQUIDATION  STATEMENT    145 


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146  THE  LEDGER 

$44,272  shown  by  the  deficiency  account  described  in 
connection  with  the  statement  of  affairs  in  Chapter  XII. 
In  order  to  render  a  complete  report  of  the  receiver's 
administration,  a  cash  account  and  a  receiver's  balance 
sheet  at  the  close  of  the  liquidation  should  also  be  pre- 
pared.   These  are  shown  in  succeeding  sections. 

7.     Assets  to  be  Realized 

This  is  a  list  of  assets  as  they  appear  on  the  state- 
ment of  affairs  at  their  "expected  to  realize"  values,  in- 
cluding assets  pledged  as  security  for  liabilities.  The 
receiver  is  assumed  to  have  realized  the  value  of  pledged 
assets  and  to  have  applied  that  value  in  settlement  of 
the  secured  liabilities. 

As  a  matter  of  fact,  secured  creditors  would 
ordinarily  collect  their  claims  from  the  security  which 
they  hold,  remitting  to  the  receiver  only  any  excess 
realized  over  their  claims.  If  a  secured  creditor  proves 
to  be  only  partially  secured,  he  would  present  a  claim 
to  the  receiver  for  the  deficit  on  his  account;  to  the 
extent  of  that  deficit  he  would  become  an  unsecured 
creditor  and  be  entitled  to  share  in  the  dividends  paid 
to  such  creditors.  Thus  the  real  estate  and  buildings 
are  included  among  the  assets  to  be  realized;  although 
if  their  valuation  was  the  only  amount  realized,  the 
liquidator  would  receive  nothing,  because  that  sum 
would  be  retained  by  the  mortgagee.  It  is  desirable, 
however,  to  include  these  pledged  assets  among  the 
assets  to  be  realized  so  that  the  realization  and  liquida- 
tion statement  will  be  clearly  shown  to  be  complete. 

The  values  at  which  the  assets  to  be  realized  are 
listed  in  the  present  statement  are  those  at  which  they 


REALIZATION  AND  LIQUIDATION  STATEMENT    147 

appear  in  the  statement  of  affairs,  the  basis  of  valuation 
being  for  a  "gone"  instead  of  a  "going"  concern. 

Cash  is  included  among  the  assets.  This  procedure 
might  be  criticized  upon  the  ground  that  realizing  assets 
means  converting  them  into  cash  and  therefore  cash 
received  by  the  liquidator  is  already  "realized."  It  is 
better,  however,  to  include  it  in  order  to  make  the  list 
of  assets  complete.  The  credit  side  of  the  statement 
shows  that  the  cash  is  listed  there  as  an  asset  realized; 
thus  the  entry  for  cash  has  no  effect  upon  the  profit  or 
loss  resulting  from  the  liquidation. 

The  total  of  the  assets  to  be  realized  is  $37,436 ;  the 
section  entitled  "Assets  Realized"  on  the  credit  side  of 
the  statement  shows  that  $38,436  was  secured  for  them. 
In  other  words,  the  assets  have  realized  $1,000  more 
than  the  receiver  expected.  The  details  composing  this 
increase  are  discussed  below  in  §  9. 

8.  Liabilities  to  be  Liquidated 

These  items  are  listed  at  the  beginning  of  the  state- 
ment in  order  to  show  the  deficiency  of  $21,203  at  the 
time  the  liquidator  takes  control.  In  this  statement  all 
liabilities  are  listed.  None  are  deducted  from  assets  as 
in  the  statement  of  affairs  because  each  liability  must 
be  paid.  The  liabilities  to  be  liquidated  as  listed  on  the 
present  statement  equal  the  book  value  of  the  liabilities 
as  they  appear  on  the  statement  of  affairs. 

9.  Assets  Realized 

As  the  liquidator  realizes  cash  on  the  sale  or  the 
collection  of  assets  he  will  charge  his  cash  account  as 
shown  later  and  will  credit  the  account  for  the  asset 


148  THE  LEDGER 

which  is  realized.  The  result  of  this  realization  will  be 
noted  in  the  realization  and  liquidation  statement  under 
the  caption  "Assets  Realized."  Each  asset  listed  must 
be  accounted  for,  either  as  actually  realized  or  as  un- 
realizable. In  the  latter  event  the  asset  should  be  noted 
in  a  section  on  the  right-hand  side  of  the  statement 
entitled  "Assets  Unrealized." 

The  cash  of  $7,186  might  be  listed  as  the  first  item 
in  the  assets  realized  section  because  it  was  realized 
before  the  liquidator  received  it;  but  it  is  listed  at  the 
end  on  the  present  statement  because  it  is  relatively 
unimportant.  The  cash  is  inserted  on  both  sides  of  the 
statement  merely  to  afford  easy  comparison  between 
the  assets  as  they  are  listed  here  and  on  the  statement 
of  affairs.  An  examination  of  the  amounts  realized 
on  other  assets  shows  that  the  assets  had  been  appraised 
in  the  preparation  of  the  statement  of  affairs  on  too 
conservative  a  basis. 

10.  Supplementary   Credits 

When  an  asset  not  listed  among  those  to  be  realized 
unexpectedly  proves  of  value,  the  credit  for  it  should 
not  be  stated  under  the  section  entitled  "Assets  Rea- 
lized" because  to  do  so  would  disturb  the  comparison 
between  appraised  and  realized  values.  Accordingly 
the  collection  of  $240  on  accounts  receivable  considered 
worthless  is  noted  in  a  separate  section  entitled  "Sup- 
plementary Credits." 

11.  Liabilities  Liquidated 

When  the  receiver  pays  liabilities  he  credits  his  cash 
account  and  charges  that  for  the  liability  which  is  settled 


REALIZATION  AND  LIQUIDATION  STATEMENT    149 

and  notes  the  fact  of  settlement  on  the  statement  under 
the  section  entitled  "Liabilities  Liquidated."  Each 
liability  listed  must  be  accounted  for  either  as  liquidated 
or  unliquidated.  In  the  latter  case,  it  should  be  entered 
in  a  separate  section  entitled  "Liabilities  Unliquidated." 
The  present  statement  shows  that  the  preferred  and  the 
secured  liabilities  have  been  paid.  It  shows  also  that  a 
dividend  of  35%  has  been  paid  to  the  unsecured 
creditors  who  held  accounts  payable  to  the  extent  of 
$26,589  and  notes  payable  of  $11,000.  35%  of  this 
total  is  $13,156  as  it  appears  in  this  statement. 

12.  Supplementary  Debits 

The  expenses  of  the  liquidator  and  his  fee  for  ser- 
vices, amounting  to  $900,  are  stated  as  a  supplementary 
debit  because  this  item  is  an  expense  not  provided  for  in 
the  statement  of  affairs.  The  credit  to  offset  this  charge 
is  to  the  receiver's  cash  account. 

13.  Liabilities  Unliquidated 

In  order  to  show  the  outcome  of  the  liquidation  it  is 
necessary  to  carry  forward  the  liabilities  unliquidated 
and  this  is  accomplished  by  listing  them  in  a  section  so 
entitled.  These  liabilities  appear  in  the  receiver's 
balance  sheet  shown  below. 

14.  Receiver's  Cash  Account  and  Balance  Sheet 

A  complete  report  of  the  receiver's  administration 
should  include  a  cash  account  and  a  balance  sheet.  The 
cash  account  contains  a  record  of  the  cash  received  and 
paid  out  by  the  receiver.  It  will  start  with  the  balance 
on  hand  at  the  time  he  took  charge;  it  will  be  debited 


150 


THE  LEDGER 


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REALIZATION  AND  LIQUIDATION  STATEMENT    151 


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with  the  proceeds  of  the  assets  realized  and  with  any 
income  received  by  him  during  realization;  it  will  be 
credited  with  the  amount  of  the  liabilities  liquidated 
and  with  any  expenses  paid  during  realization. 

The  receiver's  balance  sheet  should  show  the  financial 
condition  of  the  insolvent  business  at  the  date  of  the 
accounting  although  the  liquidation  may  not  have  been 
completed.  It  should  state  the  cash  and  other  assets 
on  hand,  the  liabilities  unliquidated,  and  the  profit  or 
loss  to  the  date  of  the  accounting. 


CHAPTER    XIV 
THE  USE   OF   SUPPORTING   SCHEDULES 

1.      Interpretative  Presentation 

The  object  of  all  statement  preparation  is  an  intelli- 
gible presentation  of  significant  financial  and  operative 
facts.  A  statement  is  inadequate  and  its  information  is 
not  properly  presented  if  the  user  of  it  is  not  reasonably 
able  to  understand  it.  Significant  facts  are  not  truly 
presented  unless  they  are  so  stated  that  they  stand  out 
distinct  from  facts  which  are  not  significant.  Thus,  the 
preparation  of  an  adequate  balance  sheet,  statement  of 
profit  and  loss,  or  other  accounting  exhibit  involves  much 
more  than  a  mere  presentation  of  figures.  It  requires 
an  interpretative  presentation — one  that  can  be  under- 
stood by  the  persons  for  whose  information  it  is  drawn 
up  and  one  that  clearly  invites  attention  to  all  facts 
which  are  really  significant. 

A  statement  may  be  true  and  yet  not  interpretative. 
For  example,  if  the  net  profits  of  a  business  for  the  years 
from  1914  to  1918,  both  inclusive,  were  respectively 
$10,000,  $8,000,  $7,000,  $6,000,  and  $4,000,  a  statement 
that  the  average  net  profits  during  the  period  of  five 
years  were  $7,000  would  be  true,  but  it  would  not  pre- 
sent the  significant  fact  that  the  profits  had  been  steadily 
decreasing.  Further,  a  statement  may  be  true  but  so 
lengthy  or  complex  that  the  significant  facts  are 
obscured.  To  illustrate,  a  balance  sheet  may  list  the 
assets  and  liabilities  in  complete  detail,  without  grouping 

153 


154  THE  LEDGER 

or  classification,  and  thus  obscure  the  fact  of  an  insuffi- 
ciency or  even  a  complete  lack  of  working  capital. 

2.      Fundamental  Principle  of  Presentation 

The  fundamental  principle  of  interpretative  presen- 
tation is  that  conclusions  in  concise  summaries  should  be 
stated  first,  followed  by  schedules  of  the  facts  from  which 
the  conclusions  have  been  drawn.  A  statement  prepared 
in  accordance  with  this  principle  discloses  first  in  sum- 
mary form  all  the  significant  facts  which  it  is  intended  to 
convey,  and  then  by  means  of  supporting  schedules, 
elaborates  and  amplifies  the  conclusions  first  stated. 
The  person  who  reads  such  a  statement  may  be  contented 
with  the  summarized  conclusions  if  the  facts  in  outline 
form  tell  him  what  he  wants  to  know;  but  if  he  wishes 
more  detailed  information  he  may  read  further  and  find 
all  the  figures  and  data  upon  which  the  conclusions  are 
based.  A  busy  executive  or  proprietor  should  be  given 
the  gist  of  the  statement  at  once,  leaving  him  to  decide 
the  extent  of  further  inquiries. 

For  example,  a  balance  sheet  even  when  its  items 
are  combined,  grouped,  and  classified,  may  be  long  and 
complex.  In  that  event,  its  reading  and  study  are 
materially  assisted  by  a  preface  which  may  be  in  narra- 
tive or  statement  form  summarizing  the  principal  facts 
noted  thereon.  Such  a  preface  might  take  the  following 
form: 

From  the  balance  sheet,  Exhibit  A,  it  appears  that 

the  assets  amount  to $601,982.47 

Deducting  from  this  total,  the  liabilities  of 162,412.78 

Leaves  a  capital  investment  of $439,569.69 


THE  USE  OF  SUPPORTING  SCHEDULES  155 

3.  Method  of  Presentation 

When  statements  take  the  form  of  summaries  and 
supporting  schedules,  their  use  is  greatly  facilitated  by 
a  proper  system  of  identification  through  the  use  of 
letters  and  numbers.  To  be  of  the  most  value,  the 
system  should  be  logical  and  uniformly  applied.  Prin- 
cipal statements  may  be  designated  as  "Exhibits,"  state- 
ments supporting  exhibits  as  "Schedules,"  supporting 
details  for  schedules  as  "Statements,"  and  finally,  any 
supporting  details  for  statements  should  be  called  "Sub- 
statements,"  Exhibits  are  usually  lettered  and  all  other 
statements  numbered,  a  new  series  of  numbers  being 
used  for  each  group  of  similar  schedules,  statements  and 
sub-statements. 

4.  Example   of   Exhibits,   Schedules,   and   Supporting 

Statements 

The  application  of  this  method  to  a  complicated 
corporate  balance  sheet  and  statement  of  profit  and  loss 
may  be  illustrated  by  the  following  list  which  covers  the 
statements  most  commonly  prepared  for  the  information 
of  the  management  of  a  large  organization: 

Exhibit  A.    Balance  Sheet,  December  31,  1918: 

Schedule  1.  Notes  Receivable 

2.  Accounts  Receivable 

2.  Statement  1 — Doubtful  Accounts  Receivable 

3.  Merchandise  Inventories 

8.    Statement    1 — Merchandise    in    Hands    of    Con- 
signees 

4.  Investments 

4.  Statement  1 — Tax-Free  Investments 

5.  Accounts  Payable 

6.  Surplus  Adjustments 


156  THE  LEDGER 

Exhibit   B.       Statement   of   Profit   and   Loss   for   the   Year 
Ended  December  31,  1918: 

Schedule  1.    Sales,  by  Departments 

1.    Statement    1 — Chemical    Department    Sales,   by 
Products 

1.  Statement   1 — Sub-statement   1 — Sulphuric  Acid 

Sales,  by  Territories 

2.  Cost  of  Goods  Sold,  by  Departments 
8.    General   Expense 

The  system  of  identification  proposed  above,  like 
many  other  matters  of  accounting  procedure,  is  subject 
to  differences  of  opinion  among  accountants.  This 
necessarily  follows  from  the  fact  that  the  preparation 
of  statements  which  picture  financial  conditions  and 
results  is  more  of  an  art  than  a  science  and  no  hard  and 
fast  rules  can  govern  all  cases.  In  the  illustration  used 
above,  some  accountants  might  show  surplus  adjust- 
ments as  Exhibit  C  instead  of  presenting  them  as  a 
schedule  supporting  the  balance  of  surplus  appearing 
on  the  balance  sheet,  Exhibit  A.  Other  accountants 
might  deviate  from  the  suggested  method  in  not  differ- 
entiating between  schedules  and  statements ;  or  in  num- 
bering consecutively  all  supporting  schedules  and  state- 
ments, in  which  case  Exhibit  B,  Schedule  1,  Statement  2, 
would  become  Schedule  or  Statement  13.  The  choice 
of  methods  in  each  case  is  a  matter  requiring  accounting 
judgment. 

The  content  of  each  exhibit,  schedule,  or  statement 
is  a  matter  of  judgment  and  the  general  principle  and 
method  outlined  may  be  applied  by  individual  account- 
ants with  varying  results.  The  following  sections  call 
attention  to  certain  matters  which  should  be  considered 
in  preparing  supporting  schedules. 


THE  USE  OF  SUPPORTING  SCHEDULES  157 

5.  Schedule  of  Notes  Receivable  or  Payable 

One  of  the  most  important  facts  to  be  brought  out 
in  a  schedule  of  notes  receivable  or  notes  payable  is  the 
amount  maturing  each  month.  Obviously,  the  expected 
receipts  and  payments  on  account  of  notes  are  factors 
to  be  considered  in  providing  the  requisite  working 
capital.  Thus,  the  schedule  of  notes  may  conveniently 
group  them  by  maturity  dates.  When  notes  receivable 
have  been  discounted,  the  contingent  liability,  which  is 
discussed  in  Chapter  XXVII,  may  properly  be  noted 
on  the  schedule  of  notes  receivable.  This  can  be  accom- 
plished by  listing  in  a  separate  group  all  unmatured 
notes  which  have  been  discounted.  Notes  from  or  to 
proprietors,  officers,  or  employees  should  not  be  com- 
bined with  those  from  customers  or  to  creditors,  banks, 
and  other  persons  outside  the  business  organization. 
Therefore,  a  schedule  listing  notes  receivable  or  payable 
would  ordinarily  contain  no  reference  to  notes  received 
from  or  given  to  proprietors,  officers,  or  employees 
because  such  notes  should  not  be  included  in  the  totals 
shown  on  the  balance  sheet  which  the  schedule  supports. 

6.  Schedule  of  Accounts  Receivable 

In  the  arrangement  of  a  schedule  of  accounts  receiv- 
able, a  wide  latitude  is  permissible.  If  the  accounts  are 
numerous,  an  indiscriminate  list,  arranged  in  order  of 
amounts  or  alphabetically  would  generally  be  of  little 
value.  Ordinarily  such  a  schedule  should  be  prepared 
only  with  a  definite  object  in  view.  Sometimes  a  list 
by  geographical  groupings  such  as  states,  counties,  or 
cities,  or  by  geographical  territories  covered  by  branches 
or  agents,  gives  valuable  information  and  the  schedule 


158  THE  LEDGER 

may  so  group  the  accounts;  or  accounts  may  be  stated 
from  the  credit  man's  viewpoint  by  grouping  them 
according  to  their  age. 

Another  point  which  may  be  brought  out  in  a  sche- 
dule of  accounts  receivable  is  the  number  of  new  cus- 
tomers and  the  extent  of  their  purchases.  In  much  the 
same  way  the  schedule  may  indicate  which  accounts  are 
normally  active  by  grouping  them  according  to  the  value 
of  current  sales  compared  with  sales  during  similar 
periods  of  preceding  years.  Whenever  a  schedule  of 
accounts  receivable  serves  any  reasonable  end  it  should 
be  prepared;  but  in  the  absence  of  a  definite  purpose,  its 
preparation  would  be  a  waste  of  effort. 

7.     Schedule  of  Inventory 

Perhaps  the  most  important  fact  to  be  emphasized 
in  a  schedule  of  merchandise  inventory  is  the  relation 
between  material  and  goods  fit  for  current  use  and  mer- 
chandise which  is  suitable  only  for  sale  at  reduced  prices 
or  as  scrap.  In  many  cases  a  schedule  of  the  inventory 
may  be  arranged  to  show  the  principal  items  which 
compose  each  kind  or  group  of  merchandise. 

Another  significant  fact  to  be  noted  in  connection 
with  the  inventory  is  the  amount  of  merchandise  out 
on  consignment.  Such  goods  are  properly  to  be  in- 
cluded in  the  merchandise  inventory  because  title  to 
them  has  not  passed  to  the  consignees.  But  possession 
and  custody  have  been  surrendered  and  the  goods  are 
not  subject  to  the  same  care  nor  are  they  held  under 
the  same  market  conditions  as  are  goods  in  the  immedi- 
ate possession  of  the  owner.  Hence  it  is  of  value  to 
know  what  portion  of  the  inventory  is  in  the  hands  of 


THE  USE  OF  SUPPORTING  SCHEDULES  159 

consignees  and  the  schedule  should  make  this  clear.  For 
similar  reasons  the  schedule  should  indicate  the  location 
of  merchandise  in  different  warehouses  when  it  is  so 
distributed. 

8.  Schedule  of   Investments  >> 

The  schedule  of  investments  should  first  of  all  group 
separately  the  bonds,  stocks,  real  estate  mortgages,  and 
any  other  kind  of  security.  The  amount  of  information 
to  be  given  concerning  each  kind  will  depend,  of  course, 
upon  the  contemplated  uses  of  the  schedule,  but  the 
following  suggestions  may  be  of  value.  For  bonds  there 
should  be  shown  the  cost  or  the  book  value,  the  market 
price,  and  the  amount,  if  any,  of  interest  in  default. 
(For  a  complete  discussion  of  these  points  see  Volume 
IV.)  Stocks  should  be  listed  to  show  their  cost  and 
market  values  and  the  rate  of  dividends  which  are  being 
received.  The  list  of  real  estate  and  mortgages  should 
show  not  only  the  amounts,  rates,  and  maturities,  but 
also  the  location  of  all  property  covered  by  the  mort- 
gages. 

9.  Schedule  of   Capital   or  Surplus    Adjustments 

The  amount  of  capital,  or  capital  stock  and  surplus 
in  the  case  of  a  corporation,  appears  on  the  balance 
sheet,  and  in  simple  cases  the  changes  in  capital  during 
the  fiscal  period  due  to  profits,  losses,  contributions,  or 
withdrawals  can  usually  be  indicated  on  the  balance 
sheet  itself.  In  complicated  cases,  however,  and  also 
where  it  is  desired  to  show  only  the  financial  condition 
without  disclosing  the  profits  or  losses  or  other  causes 
for  changes  in  capital,  the  balance  sheet  should  be  sup- 


160  THE  LEDGER 

ported  by  a  schedule  of  capital  or  surplus  adjustments 
during  the  fiscal  period.  Such  a  schedule  may  conven- 
iently take  the  form  of  a  "running"  statement  showing 
first  the  balance  of  capital  at  the  beginning  of  the  period. 
Then  should  follow  any  necessary  adjustments  of  that 
balance  due  to  corrections  applicable  prior  to  the  begin- 
ning of  the  period  (see  chapter  on  surplus  adjust- 
ments in  Volume  IV.)  Additions  to  capital  due  to 
profits  or  contributions  of  new  capital  should  next  be 
noted.  From  the  total  thus  obtained  the  reductions  in 
capital  should  be  deducted.  Reductions  may  be  due  to 
losses  or  withdrawals  of  capital.  The  schedule  should 
close  with  the  balance  of  capital  at  the  end  of  the  fiscal 
period  as  stated  on  the  balance  sheet. 

10.      Schedule  of  Sales 

The  schedule  of  sales  should  show  all  the  analysis  of 
sales  required  for  administrative  purposes.  The  widest 
latitude  exists.  Sales  may  be  analyzed  by  departments, 
products,  territories,  salesmen,  or  months,  or  by  any 
combination  of  these  bases,  or  on  any  other  basis  which 
would  be  useful.  In  a  comparatively  small  business  the 
sales  records  can  be  so  kept  as  to  collect  currently  all 
the  figures  which  will  be  needed  for  the  schedule  of 
sales  at  the  end  of  the  fiscal  period.  In  a  large  business 
this  would  be  impracticable  because  of  the  variety  of 
analyses  required.  The  best  solution  is  the  use  of  a 
tabulating  machine  such  as  that  described  in  Volume  II. 
By  means  of  the  machine  which  sorts  and  tabulates 
cards,  punched  currently  to  record  all  the  significant 
facts  concerning  each  sale,  these  facts  can  be  classified 
and  summarized  with  little  effort  in  any  desired  way. 


THE  USE  OF  SUPPORTING  SCHEDULES  161 

The  schedule  of  sales  can  then  be  prepared  to  present 
the  data  obtained  by  the  use  of  the  machine. 

II.  Schedule  of  Cost  of  Goods  Sold 

The  cost  of  goods  sold  is  a  most  important  statistical 
figure  for  use  in  administrative  control.  The  calcula- 
tion of  the  turnover  (as  noted  in  Chapter  XIX)  and 
many  significant  percentages  are  based  thereon.  In  a 
manufacturing  business  the  determination  of  the  cost 
of  goods  sold  requires  a  complete  and  practically  sepa- 
rate accounting  system,  which  is  described  in  Volume 

III.  In  a  mercantile  or  trading  business  the  calculation 
of  its  cost  is  generally  made  in  a  statement  prepared 
from  the  ledger  accounts  and  such  a  statement  makes  a 
useful  schedule  to  support  an  exhibit  showing  the  profit 
and  loss  of  the  business. 

In  drawing  up  a  schedule  of  the  cost  of  goods  sold, 
the  salient  facts  to  be  disclosed  are: 

1.  Inventories  at  the  beginning  of  the  period. 

2.  Purchases  of  goods  and  amount  returned,  if  any. 

3.  Allowances  obtained  from  merchandise  credi- 

tors for  defective  goods. 

4.  Inward  freight. 

5.  Inventories  at  the  end  of  the  fiscal  period. 

These  figures  when  used  as  explained  in  Chapter  IX 
show  the  cost  of  goods  sold.  This  cost  should  be 
analyzed  to  correspond  with  the  analysis  of  sales  of  any 
department  or  product  or  other  unit  on  which  it  is 
desired  to  determine  the  gross  profit.  Except  for  the 
purpose  of  calculating  gross  profit,  the  schedule  of  cost 
of  goods  sold  need  not  follow  the  form  and  arrangement 
of  the  schedule  of  sales. 


162  THE  LEDGER 

12.  Schedule  of  General  Expenses 

It  is  the  practice  of  many  bookkeepers  to  use  a  gen- 
eral expense  account  as  a  "catch-all"  instead  of  provid- 
ing more  specific  accounts  for  items  which  at  the  first 
glance  do  not  seem  to  be  chargeable  to  any  particular 
expense  account.  This  is  to  be  deprecated,  as  sound 
accounting  requires  the  adequate  classification  of  ac- 
counts and  the  careful  analysis  of  transactions.  Given 
this  analysis,  there  may  still  be  numerous  charges  to 
general  expense  and  if  their  total  is  considerable  a 
schedule  should  be  prepared  to  explain  the  content  of  the 
item,  General  Expense,  on  the  statement  of  profit  and 
loss.  On  the  schedule  similar  charges  should  be  grouped 
and  suitable  captions  provided.  For  example,  occasional 
fees  paid  to  lawyers  or  accountants,  and  any  unusual 
losses  or  expenses  which  are  too  general  in  their  nature 
to  be  applicable  to  any  one  department  or  to  be  combined 
with  any  regular  recurring  expense  may  appear  in  the 
schedule. 

13.  Miscellaneous  Schedules 

Other  schedules  not  enumerated  herein  may  often 
be  of  value  in  special  cases.  For  example,  schedules  of 
plant  and  machinery,  or  a  schedule  of  production  show- 
ing the  kinds  and  quantities  of  goods  manufactured, 
and  another  of  selling  expense,  by  territories,  by  sales- 
men, by  products  sold,  or  on  any  other  desired  plan, 
often  furnish  valuable  administrative  information.  Fre- 
quently, also,  a  schedule  of  cash  is  useful.  In  some  cases 
this  will  be  merely  a  list  of  balances  on  deposit  in  banks 
and  on  hand  in  various  funds  held  by  agents ;  in  others, 
it  may  be  a  statement  of  receipts  and  payments  such 


THE  USE  OF  SUPPORTING  SCHEDULES  163 

as  is  described  in  Chapter  X,  the  purpose  of  which  is  to 
account  for  the  change  in  the  cash  balance  since  the  last 
preceding  balance  sheet.  In  fact,  the  only  limit  on 
schedule  preparation  is  practicability.  A  schedule  should 
be  prepared  in  every  case  where  a  statement  of  detail 
would  clarify  an  item  on  any  exhibit  or  schedule,  pro- 
vided, of  course,  that  the  benefit  to  be  derived  from  the 
schedule  justifies  the  cost  of  preparing  it. 


In  conclusion  the  fundamental  principle  may  be 
restated — let  concise,  summarized  conclusions  be  sup- 
ported by  adequate  schedules  so  that  the  reader  is  given 
both  a  broad  view  of  the  whole  situation  and  a  knowl- 
edge of  the  detail  facts.  Only  when  statements  are  so 
prepared  do  they  render  full  service  to  the  busy  execu- 
tive and  to  other  persons  who  are  to  use  them. 


REVIEW    QUESTIONS 

1.  What  purpose  does  the  use  of  supporting  schedules  serve? 

2.  Under  what  conditions  would  you  submit  a  schedule  of  accounts 

receivable  to  accompany  a  balance  sheet?  Would  such  a 
schedule  ever  be  submitted  without  reference  to  a  balance 
sheet?  What  useful  information  may  be  secured  from  a 
schedule  of  accounts  receivable  properly  prepared? 

3.  What  value  exists  in  accompanying  a  schedule  of  new  customers 

with  one  showing  the  inactive  accounts? 

4.  What  information  should  be  disclosed  by  an  inventory  schedule? 

Of  what  value  is  such  a  schedule? 

5.  A  cash  statement  bears  what  relation  to  a  schedule  of  maturing 

notes  ? 

6.  Name  the  principal  schedules  that  may  support  a  statement  of 

profit  and  loss. 


Part  III 
Simple  Journal  Records 


CHAPTER    XV 
THE  JOURNAL 

1.  Insufficiency  of  Ledger  Record 

When  analyzing  the  nature  of  a  business  transac- 
tion, the  primary  object  in  mind  is  to  record  it  correctly 
in  the  proper  ledger  accounts.  So  far,  the  discussion 
has  made  no  reference  to  the  manner  in  which  trans- 
actions reach  the  ledger.  From  what  has  been  written 
it  is  possible  to  assume  that  accounts  may  be  debited 
and  credited  direct  from  the  original  documents  which 
furnish  the  data  and  figures  to  be  entered  in  the  ledger. 
While  this  procedure  theoretically  is  possible  and  is  all 
that  is  required  to  furnish  correct  periodical  statements 
of  financial  condition  and  profit  and  loss,  the  ledger 
presents  certain  deficiencies  as  the  only  book  of  perma- 
nent record.  In  practice  it  is  found  safer,  more  con- 
venient, and  more  economical  of  time  and  labor  to 
record  all  transactions  in  a  book  of  original  entry 
before  transferring  them  to  the  ledger.  This  phase  of 
the  subject  will  now  be  discussed. 

2.  Illustrative  Problem 

The  deficiency  of  the  ledger  when  used  as  the  only 
book  of  permanent  record  can  best  be  illustrated  by 
example.  We  will  assume  that  the  following  trans- 
actions took  place  during  the  week  of  March  24,  1919: 

24.    Merchandise  purchased  from  Adam  Smith  on 
account  $2,000. 

167 


168  SIMPLE  JOURNAL  RECORDS 

25.  Office  salaries  paid  $35. 

26.  Merchandise   sold   to    Henry   White    on    ac- 

count $3,000. 
28.    Merchandise    purchased    on    account    from 

Adam  Smith  $2,000;  John  Thompson  & 
Co.  $11,500;  Brown  &  Son  $1,500.  Mer- 
chandise sold  for  cash  $500. 

The  ledger  accounts  in  which  these  entries  were  recorded 
would  appear  as  follows : 

Merchandise 


1919 

March  24  Adam  Smith. . .  $  2,000.00 

28  Adam  Smith. . .  2,000.00 
J.  Thompson  & 

Co 11,500.00 

Brown  &  Son. .  1,500.00 


1919 

March  26  H.  White $3,000.00 

28  Cash    500.00 


Henry  White 


1919 
March  26  Mdse    $3,000.00 


Adam  Smith 


1919 

March  24  Merchandise $2,000.00 

28  Merchandise 2,000.00 


Office  Salaries   (Expense) 


1919 
March  25  Cash $35.00 


Cash 


1919 
March  28  Merchandise $500.00 


1919 
March  25  Office  Salaries $35.00 


THE  JOURNAL  169 

J.  Thompson  &  Co. 


1919 
March  28  Merchandise. . .  $11,500.00 


Brown  &  Son 


1919 
March  28  Merchandise $1,500.00 


To  record  business  transactions  directly  in  the 
ledger  accounts  affected  as  here  shown  would  render 
any  system  of  account-keeping  uncertain  and  unsatis- 
factory, for  reasons  which  may  be  briefly  enumerated 
as  follows: 

1.  In  entering  the  debits  and  credits  of  a  trans- 

action, the  debit  might  be  recorded  properly 
and  the  credit  entry  might  be  forgotten  or 
vice  versa. 

2.  The  debit  entry  might  be  made  on  the  credit 

side  of  the  account  instead  of  the  debit  side 
or  vice  versa. 

3.  An  entry  might  be  placed  in  the  wrong  account. 

4.  If  transactions  were  entered  in  the  first  instance 

directly  into  the  accounts,  the  records  could 
be  more  readily  falsified  and  the  cash  appro- 
priated by  a  bookkeeper  with  access  to  the 
cash.  All  that  would  be  necessary  would  be 
to  enter  fictitious  amounts  in  the  ledger  ac- 
counts and  such  manipulations  would  prob- 
ably remain  undetected  unless  the  amounts 
involved  were  large  enough  to  arouse  sus- 
picion. 


170  SIMPLE  JOURNAL  RECORDS 

A  bookkeeping  system  should  reduce  the  possibility 
of  errors  to  a  minimum,  should  aid  as  much  as  possible 
in  locating  errors  when  present  in  the  books,  and  should 
make  it  difficult  for  one  to  tamper  with  the  records. 
Since  the  ultimate  purpose  of  bookkeeping  is  to 
record  business  transactions  correctly  in  proper  ledger 
accounts,  means  should  be  provided  to  insure  the  correct- 
ness of  the  records  and  to  reduce  to  a  minimum  the  possi- 
bility of  fraudulent  practice. 

3.  The  Function  of  the  Journal 

One  means  of  protection  is  the  use  of  a  detailed 
record  known  as  the  "journal."  The  journal  is  a  book 
of  original  entry,  in  which  a  first  record  of  business 
transactions  is  made.  Each  transaction  day  by  day  is 
analyzed  into  its  debit  and  credit  elements,  and  these 
debits  and  credits,  after  entry  in  the  journal,  are  later 
at  some  convenient  time  transferred,  i.e.,  posted,  to  the 
proper  ledger  accounts.  This  plan  provides  a  chrono- 
logical history  or  diary  of  events  and  also  furnishes  some 
protection  against  errors  due  to  the  omission  of  trans- 
actions or  part  of  the  entries  concerning  a  transaction, 
and,  as  will  be  explained  later,  against  fraud.  Under 
double-entry  bookkeeping  every  original  entry  must  be 
made  in  a  journal  of  some  kind  to  show  the  analysis  of 
the  transaction  which  it  records;  hence  the  term  "jour- 
nalizing" is  used  to  express  the  analysis  and  recording 
of  all  original  entries. 

4.  Form  of  the  Journal 

Transactions  are  analyzed  in  the  journal  to  show 
the  nature  of  the  exchange  and  the  accounts  affected  in 


THE  JOURNAL  171 

each  case.  This  analysis  involves  the  determination  of 
what  accounts  to  debit  and  to  credit  in  order  to  show  the 
transfer  of  money  or  money's  worth,  for  which  an  equiv- 
alent transfer  is  made  or  obligation  assumed.  As  a 
means  of  recording  this  analysis  into  debits  and  credits, 
two  money  columns  are  provided,  one  for  items  to  be 
debited,  and  one  for  those  to  be  credited,  to  accounts  in 
the  ledger. 

The  entries  below  illustrate  the  arrangement  of  the 
journal  and  the  method  of  making  entries  for  the 
transactions  presented  above  in  their  account  form. 

March,  1919 

-24- 

Merchandise $  2,000.00 

To  Adam  Smith $2,000.00 

Purchase  per  invoice, 
March  23 — 3/30. 

-25- 

Office  Salaries 35.00 

To  Cash 85.00 

Office  salaries  paid  per  authorized 
voucher. 

-26- 

Henry  White 3,000.00 

To  Merchandise 3,000.00 

Sales  per  bill  rendered, 
March  25 — 3/10. 

-  28- 

Cash    500.00 

To  Merchandise 500.00 

Sale  of  merchandise  for  cash. 


172  SIMPLE  JOURNAL  RECORDS 

-28- 

Merchandise 15,000,00 

To  Sundries: 

Adam    Smith 2,000.00 

John  Thompson  &  Co 1 1,500.00 

Brown  &  Son 1,500.00 

Purchases  per  invoices  of 
March  27 — 3/30. 

As  the  object  of  a  journal  entry  is  to  record  the 
amounts  and  the  ledger  accounts  affected  by  each  trans- 
action involved,  the  names  of  the  accounts  to  be  debited 
and  credited  appear  in  the  space  devoted  to  the  explana- 
tory matter,  with  the  debit  and  credit  figures  in  the 
adjoining  columns.  To  distinguish  clearly  the  one  entry 
from  the  other,  the  explanation  of  the  credit  item  or 
items  is  usually  preceded  by  the  word  "To"  and  written 
a  little  to  the  right  of  the  explanation  of  the  debit  item 
or  items.  The  comparison  of  the  above  entries  with 
those  made  in  the  ledger  account  (see  §  2)  makes 
clear  the  method  of  making  entries.  A  glance  at  the 
first  journal  entry,  for  instance,  is  sufficient  to  indicate 
that  Merchandise  account  is  to  be  debited  with  pur- 
chases to  the  value  of  $2,000  made  from  Adam 
Smith,  and  that  the  account  of  Adam  Smith  is  to  be 
credited  with  $2,000  for  merchandise  bought  from  him. 
The  advantages  are  apparent  of  recording  in  one  place 
and  on  the  date  of  its  occurrence  all  the  data  relating  to 
a  given  transaction,  which  data  will  usually  require 
posting  to  at  least  two  and  sometimes  several  accounts. 

If  the  ledger  were  the  only  book  of  permanent 
record,  fictitious  entries  might  be  made  in  its  numerous 
pages  with  little  chance  of  their  attracting  attention; 
whereas,  when  a  complete  history  of  each  transaction 


THE  JOURNAL  173 

is  recorded  in  one  place  on  the  date  of  its  occurrence, 
all  entries  can  be  easily  scrutinized  as  to  their  correct- 
ness. Reference  to  the  business  papers  and  other 
supporting  documents  on  which  the  entries  are  based 
will,  when  necessary,  enable  anyone  to  verify  the  entries. 

5.  Importance   of   Complete   Explanation 

Each  journal  entry  should  be  accompanied  by  an 
explanation  given  in  such  detail  that  its  meaning  will 
be  plain  at  any  subsequent  time.  Frequently  jour- 
nal entries  are  difficult  both  to  make  and  to  under- 
stand because  of  the  complexity  of  facts  to  be  recorded 
and  the  analytical  skill  required  to  determine  which 
accounts  should  be  debited  and  which  credited.  If  such 
entries  are  not  sufficiently  explained,  it  becomes 
virtually  impossible  at  subsequent  times  to  understand 
them,  when  the  facts  upon  which  they  are  based  have 
been  forgotten.  An  entry  should  be  fully  explained, 
however  obvious  the  information  may  seem  at  the  time 
it  is  made  and  regardless  of  the  space  it  requires.  There 
is  no  objection  whatever  to  the  inclusion  of  a  copy  of  a 
contract  or  any  other  document  within  the  journal — 
pasted  or  copied  therein — and  there  is  no  reason  why  an 
explanation  should  not  cover  an  entire  page  or  more  if 
necessary.  Explanations  should,  of  course,  be  as  con- 
cise as  clarity  permits,  but  they  must  explain. 

6.  The  Use  of  "To"  and  "By" 

In  journal  entries  the  word  "To"  is  frequently 
found  preceding  the  name  of  the  account  to  be  credited. 
If  such  an  entry  were  to  be  stated  in  narrative  form  it 
would  be,  for  example,  "Merchandise  debited  to  Adam 


174  SIMPLE  JOURNAL  RECORDS 

Smith  who  is  credited."  This  could  be  stated  in  reverse 
order,  as  "Adam  Smith  credited  by  merchandise  which 
is  debited."  It  would,  therefore,  be  technically  correct 
to  put  the  word  "By"  preceding  the  name  of  the  ac- 
count to  be  debited,  and  the  word  "To"  preceding  that 
to  be  credited,  and  some  bookkeepers  always  do  this. 
This  is  unnecessary,  however,  and  in  modern  commercial 
practice  both  words  are  usually  omitted. 

7.      Date  and  Amounts 

Other  points  relating  to  the  date  and  amounts 
should  be  carefully  noted  because  each  is  of  practical 
importance. 

The  date  of  entry  is  placed  in  the  center  of  the  page 
instead  of  at  the  left,  for  the  purpose  of  showing  more 
clearly  each  day's  transactions.  The  month  and  year 
should  be  written  at  the  top  of  each  page,  and  whenever 
a  new  month  is  started  a  new  page  should  be  used  even 
though  there  is  ample  space  on  the  preceding  page.  The 
approved  form  of  an  entry  is  to  have  the  debit  item 
precede  the  credit,  and  this  rule  holds  even  though  there 
is  more  than  one  credit  for  each  debit  or  vice  versa. 
Sometimes  where  a  number  of  accounts  are  to  be  debited 
or  credited,  the  word  "Sundries"  is  used  as  shown  on 
the  fifth  entry  above. 

It  will  be  noted  that  the  list  of  sundry  items  is  not 
totaled.  Adding  the  items  of  a  journal  entry  is  neces- 
sary only  to  establish  the  fact  that  the  debits  equal  the 
credits.  The  totals  should  not,  however,  appear  in  the 
journal.  Nothing  of  value  would  be  obtained  by  adding 
the  columns  in  a  two-column  journal  if  each  entry  is 
separately  proved  to  be  in  balance. 


THE  JOURNAL  175 

8.  Points  to  Observe  in  Posting 

Transferring  the  record  from  the  book  of  original 
entry  to  the  ledger  accounts  affected,  is  known  as 
"posting."  After  a  posting  has  been  completed,  but 
not  before,  the  page  of  the  ledger  on  which  appears  the 
account  to  which  the  posting  has  been  made  should  be 
noted  on  the  book  of  original  entry  opposite  the  entry 
of  the  transaction  posted,  and  then  in  the  ledger  account 
a  similar  record  should  be  made  of  the  page  of  the  book 
of  original  entry  from  which  the  posting  is  made.  The 
habit  should  be  formed  of  entering  these  pages  or 
"folios,"  as  they  are  termed,  only  after  a  posting  is 
completed,  but  invariably  at  that  time.  This  provides 
a  simple  check  on  the  completion  of  the  work  so  that  if 
the  bookkeeper  is  interrupted  he  will  know,  when  he 
resumes  work,  at  exactly  what  point  the  interruption 
occurred.  Many  bookkeepers  make  a  practice  of  en- 
tering the  ledger  folio  in  the  book  of  original  entry 
before  posting,  in  the  endeavor  to  save  time  by  avoiding 
reference  to  the  index  of  the  ledger  each  time  a  posting 
is  made.  Such  a  practice  is  likely  to  cause  errors  and  is 
not  to  be  commended. 

9.  Rules  for  Journalizing 

The  practical  value  of  double-entry  bookkeeping 
consists  in  the  security  afforded  as  to  the  accuracy  of 
the  records  by  the  use  of  the  principle  of  equilibrium  or 
the  balancing  of  accounts.  In  journalizing,  the  book- 
keeper must  know  exactly  how  to  apply  this  principle 
by  knowing  what  accounts  to  debit  and  to  credit.  The 
following  rules  for  journalizing  summarize  the  informa- 
tion so  far  presented  and  are  here  given  for  reference. 


176  SIMPLE  JOURNAL  RECORDS 

They  apply  to  every  situation,  and,  if  referred  to  when 
the  journalizing  of  a  particular  transaction  is  doubtful, 
should  help  to  solve  the  difficulty. 

An  account  having  an  appropriate  caption  should  be 
debited  to  record : 

1.  Acquisition  or  increase  of  an  asset. 

2.  Cancellation  or  reduction  of  a  liability. 

3.  An  expense  or  loss. 

4.  Reduction  in  capital  due  to  withdrawal  of  assets 

by  the  proprietor  or  incurring  of  liabilities 
chargeable  to  him  personally. 

5.  Cancellation    of    a    credit    entry    or    a  credit 

balance  transferred  to  another  account. 

6.  A  debit  entry  or  a  debit  balance  transferred 

from  another  account. 

An  account  having  an  appropriate  caption  should 
be  credited  to  record : 

1.  Cancellation  or  decrease  of  an  asset. 

2.  Incurring  or  increase  of  a  liability. 

3.  A  profit  or  gain. 

4.  Increase  in  capital  due  to  contribution  of  assets 

by  the  proprietor  or  assumption  by  him  per- 
sonally of  business  liabilities. 

5.  Cancellation  of  a  debit  entry  or  a  debit  balance 

transferred  to  another  account. 

6.  A  credit  entry  or  a  credit  balance  transferred 

from  another  account. 

10.     The  Development  of  the  Journal 

In  an  attempt  to  make  the  principle  of  journalizing 
as  simple  as  possible,  the  discussion  so  far  has  been 


THE  JOURNAL  177 

confined  to  the  journal  in  its  most  elementary  form. 
In  actual  practice  the  two-column  journal  as  here 
shown — usually  referred  to  as  the  "general  journal" — 
is  used  only  for  opening,  closing,  and  adjusting  entries, 
or  in  a  small  business  where  transactions  are  few  in  num- 
ber. When,  however,  transactions  of  the  same  kind  are 
at  all  numerous,  the  clerical  work  in  making  the  original 
entry  is  much  reduced  and  accuracy  in  posting  is  ren- 
dered easier  by  segregating,  i.e.,  collecting,  similar 
transactions  within  a  journal  wholly  devoted  to  that 
type  of  transaction.  In  this  way,  after  a  number  of  like 
transactions  have  been  collected  in  their  own  book  of 
original  entry,  they  can  be  posted  in  total  form  to  the 
ledger  account  devoted  to  that  particular  type  of  trans- 
action. This  procedure  will  be  fully  explained  in  later 
chapters  discussing  different  kinds  of  journals.  At  this 
stage  of  the  discussion  it  is  necessary  only  to  state  that, 
as  in  every  business  by  far  the  greater  number  of  entries 
relate  to  cash,  purchases,  and  sales,  separate  journals  are 
usually  kept  for  each  kind  of  transaction. 


REVIEW  QUESTIONS 

1.  What  is  a  journal? 

2.  Why  are  transactions  not  entered  directly  in  ledger  accounts  ? 

3.  What  is  the  function  of  a  journal? 

4.  Define  "journalizing." 

5.  Formulate  and  explain  the  rules  for  determining  whether  the 

following  classes  of  accounts  should  be  debited  or  credited  in 
any  given  transaction.  Explain  the  application  of  the  prin- 
ciple. 

(a)  Asset  accounts. 

(b)  Liability  accounts. 

(c)  Income  accounts. 


178  SIMPLE  JOURNAL  RECORDS 

(d)  Expense  accounts. 

(e)  Capital  accounts. 

6.  (a)    Define  "debit"  in  general  terms. 

(b)    Why  is  the  word  "By"  used  in  connection  therewith,  and 
is  its  use  necessary? 

7.  (a)    Define  "credit"  in  general  terms. 

(b)    Why  is  the  word  "To"  used  in  connection  therewith,  and 
is  its  use  necessary? 


CHAPTER    XVI 

ILLUSTRATIVE  PROBLEMS  IN 
JOURNALIZATION 

1.    Transactions  to  be  Journalized 

The  principles  of  journalizing  explained  in  the  pre- 
ceding chapter  can  be  impressed  firmly  in  mind  by 
mentally  visualizing,  as  it  were,  the  debit  and  credit 
entries  of  a  number  of  transactions.  The  following  set 
of  entries  is  given  as  exercise  of  this  kind  with  the  sug- 
gestion that  each  item  be  first  mentally  journalized  and 
then  compared  with  the  correct  form  of  the  entries 
given  on  the  following  pages.  It  is  assumed  that  H. 
Hart  has  bought  a  small  retail  business.  The  bookkeeper 
is  instructed  to  open  a  new  set  of  books  based  on  the  data 
given  below.  All  items  and  transactions  are  to  be  en- 
tered on  the  general  journal.  The  assets  of  the  busi- 
ness, ascertained  by  inventories  and  from  the  records  of 
the  former  owner,  are  as  follows : 

Cash  on  hand  $500. 

Merchandise  on  hand  in  store  $4,000. 

Store  and  office  fixtures    (counters,  shelves,  desks,  etc.) 

valued  at  $200. 
Coal  on  hand  estimated  value  $25. 
Personal  accounts  owed  to  Hart  by: 

B.  Bentley  $300 

C.  Curson      200 

D.  Daley        100 

E.  Emery      200 

179 


180  SIMPLE  JOURNAL  RECORDS 

Unpaid  notes  held  by  Hart  against: 

F.  Foley       $200 

G.  Garts  100 
H.  Huron  200 
I.  Ingalls  300 
J.  Jones  300 

The  liabilities  are  as  follows: 

Unpaid  personal  accounts  owed  by  Hart: 

M.  Munson  $300 

N.  Nolan         400 

O.  Olds  200 

Unpaid  notes  and  drafts  against  Hart  held  by: 

K.  Kenyon,  draft  $600 

L.  Lawson,  note       500 

2.    Opening  the  Books  Illustrated 

The  first  entry  by  means  of  which  the  books  are 
opened  is  prepared  by  listing  the  assets  in  the  debit 
column  and  the  liabilities  in  the  credit  column  of  the 
journal,  with  the  names  of  the  account  headings  in  the 
explanation  column.  As  explained  in  Chapter  III,  the 
excess  of  assets  over  liabilities  constitutes  the  capital. 
An  account  is,  therefore,  opened  to  show  Hart's  capi- 
tal, thus  equalizing  the  debit  and  credit  entries  in  the 
journal,  and  establishing  the  equilibrium  of  the  ledger. 
Sufficient  explanatory  matter  should  be  added  to  make 
clear  the  nature  and  purpose  of  the  opening  entry,  al- 
though of  course  confidential  information  concerning 
the  terms  of  the  purchase  of  the  business  from  its  former 
owner  and  concerning  the  proprietor's  financial  arrange- 
ments should  not  be  disclosed.  A  satisfactory  entry  to 
appear  in  the  journal  would  be  as  follows: 


JOURNALIZATION  PROBLEMS  i81 

January,  1919 

-2- 

H.  Hart  this  day  begins  a  retail  busi- 
ness and  opens  a  set  of  books  to  record 
the  following  assets  and  liabilities: 

Cash    $    500.00 

Merchandise 4,000.00 

Furniture  and  Fixtures 200.00 

Expense    25.00 

B.  Bentley 300.00 

C.  Curson    200.00 

D.  Daley 100.00 

E.  Emery 200.00 

Notes  Receivable 1,100.00 

F.  Foley $    200.00 

G.  Garts 100.00 

H.  Huron 200.00 

I.  Ingalls 300.00 

J.  Jones 300.00 

To  Notes  Payable $1,100.00 

K.  Kenyon $600.00 

L.  Lawson 500.00 

"    M.  Munson 800.00 

"    N.  Nolan 400.00 

"    O.  Olds 200.00 

"    H.   Hart,  Capital 4,625.00 

3.    Transactions  in  Business 

The    following    transactions    take    place    between 
January  2  and  20 : 

2.    B.  Bentley  buys  goods  from  Hart  on  account  $50. 
D.  Daley  buys  goods  from  Hart  on  account  $25. 
8.    E.  Emery  gives  Hart  a  check  for  $50,  and  a  90-day 
note  for  balance  of  his  account. 


182  SIMPLE  JOURNAL  RECORDS 

4.    B.  Bentley  returns  to  Hart  goods  which  he  finds  to 
be  spoiled,  $10. 

6.  M.  Munson  draws  a  60-day  draft  on  Hart  for  $200, 

which  is  accepted. 

7.  F.  Foley  pays  Hart  $3  interest  on  note  held. 

8.  D.  Daley  sends  goods  to  Hart  which  the  latter  buys 

from  him  for  $35. 

9.  A  draft  Hart  drew  on  B.  Bentley  for  $175  has  been 

accepted. 

10.  Hart  purchases  a  typewriter  on  a  30-day  note  $60. 

11.  Hart  Sells  merchandise  to  H.  Johnson  on  account  $75. 
13.    Hart  paid  freight  bill  of  N.  Y.  C.  railroad  for  $15. 

15.  Hart  sold  K.  Lennon  merchandise  for  $60  on  account. 

16.  N.  Y.  C.  railroad  overcharged  Hart  $4  on  the  freight 

bill  paid  January  13.      Claim  has  been  made  for 
same. 

17.  Hart  takes   goods    from   the   store    for   his   personal 

use  $40. 

18.  Hart  sent  N.  Nolan  a  60-day  note  for  $250. 

20.  D.  Daley  makes  a  new  counter  for  Hart.      Amount 

credited  to  his  account  $15. 

21.  Hart  purchases  merchandise  from  Gibbons  &  Co.  for 

$300,  on  account. 

4.    Purchases  and  Sales 

The  entries  relating  to  purchases  and  sales  are 
simple.  Every  purchase  of  merchandise  for  resale  is 
debited  to  Purchases  account  and  credited  to  either  ( 1 ) 
Cash,  if  a  cash  transaction,  (2)  a  customer's  account 
if  on  credit,  or  (3)  to  Notes  Payable  if  Hart  accepts 
a  draft  drawn  on  him  or  if  Hart  gives  his  note  in  ex- 
change. A  purchase  of  fixed  assets  for  the  business  is 
debited  to  a  suitably  named  asset  account  and  credited 
as  above.  Thus  the  transactions  of  January  10  and 
18  relating  to  the  purchase  of  a  typewriter  and  to 


JOURNALIZATION  PROBLEMS  188 

the  cost  of  constructing  a  new  store  counter  are 
clearly  equipment  to  be  used  in  the  business  and  as  such 
are  debited  to  the  asset  account  Furniture  and  Fix- 
tures. The  credit  in  the  case  of  the  typewriter  is  to  the 
liability  account  Notes  Payable  and  in  the  case  of  the 
counter  is  to  the  credit  side  of  the  account  with  D.  Daley, 
who  is  both  a  customer  and  a  creditor  of  the  store. 
Every  sale  of  merchandise  is  credited  to  Sales  and 
debited  to  Cash,  a  customer's  account,  or  Notes  Receiv- 
able, as  the  case  may  require. 

5.    Receipts  and   Payments 

Receipts  shown  in  the  transactions  are  debited  to 
Cash  and  credited  to  either  (1)  the  person  from  whom 
the  amount  is  received  if  it  extinguishes  a  debt  owed 
to  the  business,  or  (2)  an  income  account  if  a  source 
of  income.  Thus  the  transactions  under  January  4 
and  9  involve  the  crediting  of  the  persons  making  pay- 
ments, while  the  receipt  of  January  7  is  credited 
to  the  income  account  of  interest.  In  this  case  the 
payment  of  $3  made  by  Foley  represents  not  the 
extinguishing  of  a  debt  but  the  payment  of  interest 
earned  by  the  business  for  the  credit  extended  to  Foley. 
If  it  were  required  to  show  on  the  books  that  Foley 
owed  Hart  $3  for  interest,  Foley's  account  would  first 
be  debited  and  interest  credited.  Upon  receipt  of  the 
interest  Cash  would  be  debited  and  Foley's  account 
credited  and  closed,  leaving  the  two  contra  entries  as 
shown  in  the  example  in  §  7. 

Payments  made  by  the  business,  shown  in  the  trans- 
actions, are  credited  to  Cash  and  debited  to  either  (1) 
the  person  to  whom  the  amount  is  paid  if  it  extinguishes 


184  SIMPLE  JOURNAL  RECORDS 

a  debt  owed  by  the  business,  (2)  a  suitable  expense  ac- 
count if  the  amount  represents  an  expenditure  made  for 
the  purpose  of  carrying  on  the  business,  or  (3)  an  asset 
account  if  an  asset  was  acquired.  Thus,  an  account 
opened  with  Freight  and  Express  is  charged  with  the 
amount  paid  for  this  service  on  January  13.  If  it  were 
desired  to  show  on  the  books  the  fact  that  the  business 
owed  the  N.  Y.  C.  Railroad  Company  $15  for  freight, 
Freight  and  Express  account  would  be  debited  and  the 
railroad  company  credited.  Upon  payment  of  the 
freight,  Cash  would  be  credited  .and  the  railroad  com- 
pany's account  debited  and  closed,  leaving  the  two  con- 
tra entries  as  shown  in  the  example.  Freight  charges  of 
this  kind  are  usually  paid  in  cash. 

6.    Returns  and  Allowances 

Transactions  which  represent  the  return  of  goods 
bought  or  sold,  or  an  allowance  on  the  original  invoice 
price  entered  on  the  books,  are  handled  by  a  contra 
entry  in  the  accounts  affected.  Thus  when  merchan- 
dise is  returned  by  a  customer  as  in  the  transaction  of 
January  5,  the  customer  is  credited  with  their  value  and 
Sales  account  is  debited.  When  the  N.  Y.  C.  railroad 
overcharges  on  its  freight  bill  and  a  claim  is  made  for 
the  excess  charge,  the  railroad  is  debited  and  the  ex- 
pense account  is  credited  with  the  amount,  as  in  the 
transaction  of  January  16.  In  the  first  case  a  debit  to 
the  income  account  Sales  decreases  income  by  the 
amount  of  the  returned  goods,  and  in  the  second  case 
a  credit  to  the  expense  account  Freight  and  Express 
decreases  expense  by  the  amount  of  the  claim  or  allow- 
ances. 


JOURNALIZATION  PROBLEMS  185 

7.    Solution  of  Journal  Entries 

The  correct  form  of  journal  entry  for  each  of  the 
foregoing  transactions  is  shown  below.  By  following 
the  explanation  given,  no  difficulty  should  be  experi- 
enced in  journalizing  the  ordinary  transactions  met  with 
in  every  business  as  here  illustrated : 

January,  1919 

-2- 

B.    Bentley $  50.00 

D.  Daley 25.00 

To  Sales $75.00 

-3- 

Cash 50.00 

Notes  Receivable 150.00 

To  E.  Emery 200.00 

-4- 

Sales 10.00 

To  B.  Bentley 10.00 

-6- 

M.  Munson 200.00 

To  Notes  Payable 200.00 

-7- 

Cash 3.00 

To  Interest 3.00 

-8- 

Purchases 35.00 

To  D.   Daley 35.00 

-9- 

Notes  Receivable 175.00 

To  B.  Bentley 175.00 

-10- 

Furniture  and  Fixtures 60.00 

To  Notes  Payable 60.00 


186  SIMPLE  JOURNAL  RECORDS 

-11  - 

H.  Johnson 75.00 

To  Sales 75.00 

-13- 

Freight  and  Express 15.00 

To   Cash 15.00 

-15- 

K.  Lennon 60.00 

To  Sales 60.00 

-16- 

N.  Y.  C.  Railroad 4.00 

To  Freight  and  Express 4.00 

-17- 

H.  Hart,  Drawing  Account 40.00 

To  Sales 40.00 

-18- 

N.  Nolan 250.00 

To  Notes  Payable 250.00 

-20- 

Furniture   and    Fixtures 15.00 

To  D.   Daley 15.00 

-21  - 

Purchases 300.00 

To  Gibbons  &  Co 300.00 


REVIEW    QUESTIONS 

1.    Enter  the  following  transactions  in  a  two-column  journal: 

1.  W.  Smith  began  a  general  grain  business  by 

investing  cash  $9,000;  office  furniture 
$500 ;  and  stock-in-trade  as  follows :  2,000 
bu.  wheat  at  $2.50;  3,000  bu.  corn  at  $1. 

2.  Paid  the  following  bills  in  cash:  rent  $60; 

office   supplies   $20;   office    furniture   $75. 

3.  Bought  of  C.  Jones  500  bu.  corn  at  $1.05, 

terms  2/10  n/80. 


JOURNALIZATION  PROBLEMS  187 

4.  Bought  of  A.  Haskins  500  bu.  wheat  at  $2.40, 

terms  2/10  n/30. 

5.  Bought  of  D.  Revell  400  bbl.  flour  at  $12. 

6.  Sold    S.    Swallow    800   bu.    wheat    at    $2.75 

on  account. 

7.  Sold   O.    Green   700   bu.    corn   at   $1.15    on 

account. 

8.  Sold  H.  John  90  bbl.  flour  at  $18  on  a  30-day 

note. 

9.  Discounted  personal  90-day  note  at  the  bank. 

Face  of  the  note  $7,000 ;  discount  $70. 

10.  Returned  to  D.  Revell  15  bbl.  flour  of  poor 

quality.    Received  credit  memo  for  same. 

11.  Drew  for  personal  use  $200  in  cash. 

12.  Paid  in  cash :  clerk  hire  $35 ;  cleaning  bill  $3 ; 

tips  to  porters  $2. 

13.  Bought  of  N.  Lord  600  bbl.  potatoes  at  $3, 

terms  2/10  n/30. 

14.  Sold  I.  Cooper  400  bu.  wheat  at  $2.73,  terms 

2/10  n/30. 

15.  Donated  to  the  Infants'  Welfare  Association 

2  bbl.  flour  at  $12,  cash  $10. 

16.  Sold  C.  Brown  200  bbl.  potatoes  at  $3.20  on 

account. 

17.  Paid  C.  Jones  on  account  $375,  discount  re- 

ceived 2%. 

18.  Paid  H.  Haskins  cash  in  full  of  account,  dis- 

count received  2%. 

19.  Sold  K.  Olin,  on  15-day  note,  700  bu.  wheat 

at  $2.80. 

20.  Purchased  store  property  for  $4,000  cash. 

21.  Paid  in  cash:  gas  bill  $10;  telephone  bill  $15. 

22.  Gave  C.   Jones  30-day  note  for  balance  of 

account. 

23.  Discounted  note  of  H.  John  at  5%. 

24.  Gave  S.  Revell  15-day  note  for  $3,000. 

25.  Paid  in  cash,  repairs  to  furniture  $7. 


CHAPTER    XVII 
THE    CASH    BOOK 

1.  Segregation  of  Like  Transactions 

In  every  business  where  transactions  are  numerous 
the  modern  practice  is  to  segregate  the  original  entries 
of  like  kinds  and  record  them  in  separate  books.  Much 
time  and  labor  is  thereby  saved  in  posting  and  the 
accuracy  of  both  the  journal  and  ledger  entries  is  more 
easily  insured.  In  this  part  of  the  book  the  splitting 
up  of  the  general  journal  into  "subsidiary"  journals,  as 
they  are  termed,  will  be  discussed,  leaving  for  later  con- 
sideration (Chapter  XXIV,  "Controlling  Accounts") 
the  application  of  the  same  process  to  the  general 
ledger. 

2.  Advantages  of  Subdivision  of  Journal 

The  advantages  of  subdividing  the  general  journal 
into  several  subsidiary  journals  can  be  readily  illus- 
trated by  an  example.  Let  us  assume  that  a  concern 
sells  goods  on  the  instalment  plan  of  payment.  The 
items  of  cash  received  might  then  run  into  hundreds  and 
even  thousands  daily.  If  a  general  journal  only  were 
used,  a  complete  entry  would  need  to  be  made  for  each 
cash  receipt  as  follows : 

Cash    $5.00 

To  John  Doe $5.00 

It  is  clear  that  the  work  could  be  shortened  by  first 

188 


THE  CASH  BOOK  189 

listing  the  names  of  customers  and  amounts  received 
each  day  in  some  form  of  memorandum  book  and  then 
journalizing  them  in  one  composite  entry  in  the  follow- 
ing form: 

Cash $47.00 

To  J.  Doe $5.00 

'*    T.  Smith 10.00 

"    J.  Jones 17.00 

"    F.    Jackson 15.00 

To  copy  the  names  of  persons  involved  in  cash  trans- 
actions first  in  a  memorandum  book  and  then  in  a 
general  journal  preparatory  to  posting  them  to  their 
ledger  accounts  obviously  creates  a  needless  duplica- 
tion of  entries.  It  is  much  more  convenient  and  prac- 
tical to  use  such  a  memorandum  book  as  a  permanent 
record  for  original  entries  of  cash  transactions.  So  in 
every  modern  accounting  system  the  work  is  curtailed 
by  dispensing  with  a  journal  entry  in  the  general 
journal  and  utilizing  a  cash  journal  or  cash  book  for 
the  purpose  of  journalizing  the  transactions  involving 
cash. 

3.    Development  of  Cash  Journal 

It  is  apparent  that  in  a  journal  devoted  to  the 
record  of  cash  transactions  the  mere  entry  of  an  item 
such  as : 

John  Doe $5.00 

indicates  the  receipt  of  $5  from  or  its  payment  to  the 
person  named.  If,  furthermore,  all  receipts  are  en- 
tered  on   the   left-hand   page   and    all   payments    are 


190  SIMPLE  JOURNAL  RECORDS 

entered  on  the  right-hand  page,  then  the  two  facing 
pages  of  the  cash  journal  virtually  constitute  the  whole 
detail  of  the  debit  and  credit  sides  of  the  cash  account 
in  the  ledger.  All  that  is  now  required  to  complete 
the  double-entry  record  on  the  books  is  to  post  all  cash 
receipts  to  the  credit  and  all  cash  payments  to  the  debit 
of  the  accounts  named  in  the  journal.  The  facing  pages 
of  the  cash  journal  serve  as  the  ledger  account  and  the 
recording  of  each  cash  transaction,  whether  it  be  a  re- 
ceipt or  payment,  entails  only  one  entry  in  the  cash 
book  and  one  in  the  ledger  and  still  the  principle  of 
double  entry  and  the  journalizing  of  transactions  is 
maintained. 

As  in  almost  every  business  the  cash  transactions  are 
much  more  numerous  than  those  of  any  other  kind,  mod- 
ern practice  almost  invariably  makes  use  of  a  cash  book. 
It  is  possible  to  make  the  cash  book  serve  the  double  pur- 
pose of  journal  and  ledger  account  and  to  dispense  with 
a  cash  account  on  the  ledger.  This  practice,  however,  is 
not  to  be  recommended  and,  for  reasons  to  be  explained 
presently,  the  safer  course  is  to  open  a  Cash  account  in 
the  ledger. 

4.    Receipts  and  Payments  in  Separate  Books 

In  a  business  in  which  cash  transactions  are  numer- 
ous, receipts  and  payments  may  be  entered  in  separate 
books  so  that  more  than  one  clerk  can  be  used  in  keep- 
ing them.  When  the  cash  journal  is  divided  into 
separate  books,  the  usual  practice  is  to  open  a  Cash 
account  on  the  ledger  to  which  summary  totals  of  re- 
ceipts and  payments  for  each  month  are  posted.  The 
ledger  is  thus  made  self-balancing. 


THE  CASH  BOOK 
5.    Cash  Book  Form 


191 


The  form  of  cash  book  shown  below  is  adequate 
for  ordinary  double-entry  bookkeeping  in  which  the 
transactions  are  neither  numerous  nor  complex. 


Dr. 

CASH 

Date 

L.F. 

Account  to  be  Credited 

Explanation 

Amount 

1919 
Mar. 

1 
1 
1 

V 
71 
28 

Jones  &  Curtis 

Thompson  &  Brown 

On  account 
On  account 

$2,431 

100 

7r 

72 
JO 
)0 

CASH 

Cr. 

Date 

Check 

No. 

L.F. 

Account  to  be  Debited 

Explanation 

Amount 

1919 
Mar. 

1 

1 

42 
43 

15 
57 

Gould  &   Lambert 

In  full  of  Inv. 

$  81 
84C 

00 
00 

Form  2.    Cash  Book — Simple  Form 

6.    Petty  Cash 

The  distinction  between  "cash"  and  "petty  cash" 
may  here  be  noted.  Petty  cash  generally  refers  to  a 
separate  fund  of  currency  of  a  relatively  small  amount, 
kept  distinct  from  the  general  cash  on  deposit  or 
to  be  deposited  in  a  bank.  This  fund  is  usually  kept 
in  the  office  for  the  purpose  of  making  small  payments 
such  as  postage,  carfare,  small  office  expenses,  and  the 
like.  The  method  of  recording  petty  cash  payments  will 
be  described  in  Chapter  XX. 

The  following  points  in  recording  transactions  in 
the  cash  book  need  to  be  noted: 


192  SIMPLE  JOURNAL  RECORDS 

7.  Dates 

The  month  in  which  the  entries  are  made  is  written 
plainly  at  the  top  of  each  page  so  as  to  be  readily 
apparent  on  opening  the  cash  book.  The  date  of  the 
receipt  or  payment  is  entered  at  the  left.  There  is  no 
reason  why  the  date  should  not  be  entered  in  the  center 
of  the  page,  as  in  the  journal,  excepting  that  of  con- 
venience. Cash  book  entries  are  much  more  numerous 
than  those  in  the  journal,  and  to  write  the  date  in  the 
middle  of  a  separate  line  would  cause  a  needless  waste 
of  space. 

8.  Footings 

The  columns  showing  cash  receipts  and  payments 
should  be  added  every  day  and  the  totals  shown  in  small 
pencil  figures.  This  is  necessary  in  order  to  determine 
the  balance  of  the  account,  which  is  the  excess  of  debits 
over  credits.  Whenever  the  bottom  of  a  page  of  either  re- 
ceipts or  payments  is  reached,  both  pages  should  be 
added  and  the  amounts  carried  forward  to  the  next 
page,  even  though  one  side  may  be  only  partially  filled. 
In  the  average  business  either  receipts  or  payments 
preponderate  so  that,  for  example,  ten  pages  may  be 
required  to  record  the  receipts  of  cash  while  two  page£ 
contain  current  payments.  If  in  that  case  both  totals 
were  not  brought  forward  when  each  receipts  page  was 
filled,  to  ascertain  the  balance  of  the  cash  by  a  quick 
inspection  would  necessitate  turning  back  from  the 
page  which  shows  the  total  of  receipts  to  some  preced- 
ing page  which  shows  the  total  of  payments.  It  is 
much  more  convenient  to  have  these  totals  appear 
opposite  each  other. 


THE  CASH  BOOK  193 

9.  Banking  Cash  Receipts 

To  insure  an  adequate  cash  record,  all  receipts,  no 
matter  how  small,  should  be  deposited  in  the  bank.  If 
an  amount  received  is  small,  the  money  may,  however, 
be  held  in  the  office  until  a  large  enough  sum  accumulates 
to  warrant  making  a  deposit.  Whatever  may  be  the  pro- 
cedure, when  a  deposit  is  made  such  deposit  should 
equal  in  amount  the  total  cash  receipts  from  the  time 
the  last  deposit  was  made.  For  convenience  in  proving 
the  correctness  of  the  balance  shown  by  the  cash  book, 
as  will  be  described  later,  a  deposit  should  be  made  on 
the  last  day  of  each  month  to  include  all  undeposited  re- 
ceipts, if  any,  notwithstanding  the  fact  that  the  amount 
may  be  smaller  than  is  usually  deposited  at  other  times 
during  the  month. 

Under  no  circumstances  should  amounts  received  be 
used  directly  in  making  payments,  nor  should  small 
receipts  be  put  in  the  petty  cash  fund.  The  reason  is 
that  either  practice  destroys  the  confirmation  of  the 
correctness  of  the  cash  record  secured  when  the  bank 
keeps  what  is  practically  a  duplicate  record.  Further- 
more, when  payments  are  made  with  cash  received,  the 
proof  of  payment  afforded  by  a  canceled  check  indorsed 
by  the  creditor  is  lacking,  the  cash  record  is  complicated 
with  explanations  of  transactions  out  of  the  ordinary, 
and  the  record  of  receipts  and  payments  is  incomplete. 

10.  Identification  of   Payment 

Each  payment  should  be  entered  in  the  cash  book 
with  sufficient  explanatory  detail  to  identify  it  without 
reference  to  any  other  document  or  record.  Checks 
should  be  numbered  and  the  number  of  each  entered  in 


194  SIMPLE  JOURNAL  RECORDS 

the  cash  book.  The  modern  practice  is  to  dispense  with 
the  check  book  stubs  by  making  entries  directly  in  the 
cash  book  instead  of  first  on  the  check  stub  to  be  copied 
later  into  the  cash  book. 

Sometimes  it  is  necessary  to  use  loose  checks  which 
are  not  attached  to  stubs  or  which  are  not  numbered  in 
regular  series.  In  such  cases,  care  must  be  taken  to 
make  at  the  first  opportunity  an  adequate  entry  in  the 
cash  book  for  every  check  so  issued.  Such  a  check 
should  be  given  a  number  for  purposes  of  identification, 
a  convenient  method  being  to  use  the  number  follow- 
ing that  of  the  last  regular  check  drawn.  The  regular 
check  bearing  the  number  given  to  the  loose  check 
should  then  be  destroyed.  Another  convenient  method 
is  to  give  the  loose  check  the  number  of  the  last  drawn 
regular  check  preceded  or  followed  by  the  letter  "x."  If 
a  loose  check  is  not  numbered  when  issued,  a  number 
should  be  assigned  to  it  later,  to  be  used  in  the  entry  in 
the  cash  book,  and  marked  on  the  check  when  it  is 
returned  by  the  bank  after  payment.  Neglect  of  these 
simple  precautions  may  result  in  an  unexpected  over- 
draft of  the  bank  account. 

11.    Cash  Balance 

The  most  vital  fact  shown  by  the  cash  book  is  the 
balance  of  cash  on  hand.  Since  the  balance  is  the  excess 
of  receipts  over  payments  (the  receipts  including  any 
balance  at  the  beginning  of  the  period),  the  totals  of 
both  receipts  and  payments  must  be  kept  in  order  to 
calculate  the  balance.  To  this  end  the  columns  should 
be  added  daily  and  the  totals  inserted  in  small  pencil 
figures  under  the  last  entry  in  each  column.     The 


THE  CASH  BOOK  195 

balance  itself  should  be  entered  in  pencil  in  the  explana- 
tion space  on  the  receipts  side  of  the  cash  book. 

The  accuracy  of  the  calculations  should  be  tested 
frequently ;  if  receipts  are  numerous,  at  the  end  of  each 
cash  book  page.  A  convenient  method  is  to  add  to  the 
former  balance  all  subsequent  receipts  and  to  subtract 
therefrom  the  subsequent  payments;  the  result  should 
agree  with  the  present  balance  shown  by  the  excess  of 
total  receipts  over  total  payments.  If  it  does  not  so 
agree,  the  mistake  should  at  once  be  located. 

In  order  to  apply  this  test  and  in  order  also  to  make 
monthly  postings  of  total  receipts  and  payments,  no 
attempt  should  be  made  to  balance  single  pages  of  the 
cash  book.  That  is,  the  balance  should  not  be  deter- 
mined by  totaling  in  ink  the  receipts  and  payments  on 
each  page,  subtracting  one  from  the  other  and  entering 
the  balance  or  overdraft  at  the  top  of  the  next  page. 
Such  a  method  might  lead  to  mistakes.  If  the  balance 
at  the  end  of  any  one  page  were  incorrectly  calculated, 
every  balance  thereafter  during  the  month  or  other 
fiscal  period  would  be  incorrect,  because  each  balance 
forms  the  base  of  all  subsequent  calculations. 

12.    Closing  the  Cash   Book 

It  is  customary  in  most  offices  to  close  the  cash  book 
at  the  end  of  each  month.  There  are  certain  well-known 
exceptions,  as,  for  example,  in  a  stock  broker's  office 
where  the  cash  record  is  closed  daily,  and  in  the  thea- 
trical profession  where  all  accounting  is  done  on  a 
weekly  basis.  Generally  speaking,  however,  the  month 
is  the  most  convenient  period  for  assembling  the  final 
information  concerning  cash  receipts  and  payments  and 


196  SIMPLE  JOURNAL  RECORDS 

making  the  postings  from  the  cash  book.  The  form  of 
cash  book  presented  in  Chapter  XX  shows  a  convenient 
way  to  rule  off  the  cash  book  at  the  end  of  a  month  pre- 
paratory to  making  the  ledger  postings. 

The  total  cash  receipts  for  the  month  should  be 
posted  to  the  debit  of  the  cash  account  in  the  ledger. 
This  figure  comprises  all  items  which  have  been  posted 
individually  to  the  credit  of  the  various  accounts.  The 
equilibrium  of  the  accounts  is  thus  maintained  by 
making  one  debit  equal  to  all  the  credits.  Instead  of 
a  separate  Cash  debit  for  each  receipt,  the  total  of  the 
receipts  during  the  month  is  determined  and  debited  to 
Cash.  The  debit  to  Cash,  of  course,  records  merely  the 
increase  in  that  asset.  Care  should  be  taken  in  posting 
cash  receipts  not  to  include  the  opening  balance  at  the 
beginning  of  the  month  because  that  balance  is  already 
represented  in  the  Cash  account. 

From  the  credit  side  of  the  cash  book  the  total  is 
credited  to  the  Cash  account  in  order  to  record  the  de- 
crease in  that  asset.  During  the  month  accounts  have 
been  debited  with  the  separate  payments  recorded  in 
the  cash  book,  so  that  the  equilibrium  is  maintained  by 
offsetting  the  total  of  these  debits  with  a  credit  of  the 
same  amount.  Instead  of  crediting  Cash  each  time  a 
payment  is  made,  the  total  of  the  payments  during  the 
month  is  ascertained  and  that  amount  credited  to  Cash. 

In  order  to  show  the  balance  on  hand  at  the  end  of 
the  month  in  a  neat  and  orderly  way,  it  is  written  in  ink 
under  the  total  payments  and  added  to  them.  It  is 
obvious  that  if  the  balance  of  Cash  is  the  excess  of  re- 
ceipts over  payments,  the  sum  of  the  balance  and  the 
payments  will  equal  the  receipts.     The  total  on  each 


THE  CASH  BOOK  197 

side  of  the  cash  book  can  conveniently  be  entitled  "total 
per  contra,"  since  the  total  on  each  side  is  the  same  as 
the  total  on  the  opposite  side.  It  is  evident  that  if 
postings  are  made  to  the  Cash  account  in  the  ledger 
as  suggested  herein,  the  balance  of  the  ledger  account 
will  agree  in  amount  with  the  balance  shown  by  the 
cash  book. 


REVIEW    QUESTIONS 

1.  What  are  the  advantages  of  entering  cash  transactions  in  a  cash 

book? 

2.  Describe  a  cash  book  and  show  its  relation  to  the  Cash  account. 

3.  What  should  a  Cash  account  in  the  ledger  show? 

4.  May  a  Cash  account  ever  have  a  credit  balance?     When? 

5.  Rule  a  cash  book,  entering  five  transactions  on  the  receipts  side 

and  four  on  the  payment  side.     Insert  balance,  and  close. 


CHAPTER   XVIII 
PURCHASE    RECORDS 

1.  Function  of  Purchase  Journal 

The  purchase  book  is  a  separate  form  of  journal 
designed  to  relieve  the  general  journal  of  all  purchase 
transactions.  If  each  purchase  were  separately  recorded 
among  the  other  transactions  entered  in  the  general 
journal,  every  entry  would  have  to  be  posted  in  detail 
to  the  ledger.  The  detail  work  can  be  simplified,  with- 
out violating  any  of  the  principles  of  double-entry  book- 
keeping, by  recording  purchases  in  one  place  and  posting 
them  in  total  to  the  ledger  at  the  end  of  the  month. 

2.  Simple  Form  of  Purchase  Journal 

The  purchase  journal  illustrated  below  resembles  a 
simple  two-column  general  journal.  The  details  of 
each  purchase  transaction  are  entered  in  the  first  column 
and  the  amount  to  be  credited  in  the  second.  The 
second  column  is  added  at  the  end  of  the  month  to 
secure  the  total  debit  to  be  posted  to  the  ledger. 

3.  Illustration  of  Use  of  Purchase  Journal 

The  use  of  the  purchase  journal  can  readily  be 
understood  by  comparing  the  entries  of  a  few  transac- 
tions first  journalized  in  the  ordinary  way  in  the  general 
journal  and  then  entered  in  the  purchase  journal. 
Assume  the  following  business  operations  in  October, 
1918: 

198 


PURCHASE  RECORDS  199 

1.    Bought   merchandise   from   A.   Maxwell   on   account 

$3,878.95. 
6.    Bought  merchandise  from  W.  Hess  on  account  $850. 
9.    Bought  merchandise  from  Smalley  Bros,  on  60-day 

note,  $258. 
18.    Bought  merchandise  from  L.  Sadler  on  30-day  note, 

$375.09. 

Then  if  the  ordinary  journal  were  used  in  which  to 
record  the  transactions,  the  debit  in  each  case  would 
clearly  be  to  the  ledger  account  recording  the  value  of 
the  purchase,  i.e.,  Purchases  account,  and  the  credit  to 
an  account  with  the  creditor  from  whom  the  purchase 
was  made — as  shown  below: 

October,  1918 

-1- 

Purchases    $3,878.95 

To  A.  Maxwell $3,878.95 

-6- 

Purchases 850.00 

To  W.   Hess 850.00 

-9- 

Purchases 258.00 

To  Smalley  Bros 258.00 

Smalley  Bros 258.00 

To  Notes  Payable 258.00 

-18- 

Purchases    375.09 

To   L.    Sadler 375.09 

L.  Sadler 375.09 

To  Notes  Payable 375.09 

In  the   above   examples   four   separate  debit   and 
credit  entries  are  required  in  both  the  general  journal 


200 


SIMPLE  JOURNAL  RECORDS 


and  the  ledger  to  record  the  purchases.  The  same 
purchase  transactions  entered  in  the  purchase  book  are 
reduced  to  four  credits  and  one  debit  in  both  journal  and 
ledger.  A  separate  entry  would  still  be  required  to 
record  the  giving  of  the  note  to  L.  Sadler.  This  trans- 
action is  not  a  purchase,  but  is  merely  the  settlement  of 
a  liability. 


PURCHASE  BOOK 

Date 

L.F. 

Account  to  be  Credited 

1918 
Oct. 

1 
6 
9 

18 

A.  Maxwell 
W.  Hess 
Smalley  Bros. 
L.  Sadler 

Purchases  Account  Dr. 

$3,878 
850 
258 
375 

95 
00 
00 
09 

$5,362 

04 

Form  3.     Purchase  Book 

One  posting  to  the  Purchases  account  takes  the 
place  of  the  numerous  postings  necessary  if  the  general 
journal  were  used  for  the  original  entry  of  purchases. 

4.    Purchases  Account 

The  account  to  which  purchase  transactions  are 
debited  in  the  ledger  and  to  which  reference  has  already 
been  made  in  Chapter  VIII  is  known  in  a  mercantile 
business  as  Purchases  or  Merchandise  Purchases  ac- 
count. The  purchases  may  be  recorded  in  one  or 
in  several  accounts,  determined  by  the  number  of  lines 
on  which  it  is  desired  to  ascertain  the  gross  profits. 
Gross  profit  is  the  excess  of  the  sale  price  of  a  given 


PURCHASE  RECORDS  201 

line  over  the  purchase  price.  If  there  were  no  goods 
on  hand  at  the  beginning  of  a  fiscal  period  and  if 
all  the  items  of  a  line  purchased  during  the  period 
were  sold  out  before  its  close,  it  is  apparent  that  the 
gross  profit  could  be  readily  ascertained.  The  purchases 
of  the  period  would  then  represent  the  cost  of  the  goods 
sold  and  the  excess  of  the  selling  price  over  the  cost 
of  goods  sold  represents  the  gross  profits.  In  actual 
practice,  however,  a  certain  amount  of  goods  is  usually 
on  hand  at  the  beginning  and  end  of  a  period  and  their 
values  must,  of  course,  be  taken  into  consideration. 
Before  the  cost  of  goods  sold  can  be  ascertained, 
the  value  of  the  goods  on  hand  at  the  beginning 
— i.e.,  the  opening  inventory — must  be  added  to  cur- 
rent purchases  and  from  this  total  the  value  of  the 
closing  inventory  must  be  deducted.  There  are  two 
methods  of  determining  the  amount  of  the  inventory. 

5.    Perpetual  Inventory 

A  perpetual  inventory  consists  of  records  (usually 
in  card  form)  kept  to  show  the  amount  of  merchan- 
dise on  hand.  A  separate  card  is  allotted  to  each 
line  of  goods;  purchases  are  debited  as  goods  are 
received  while  sales  are  credited  as  made,  but  at  their 
cost  price.  The  excess  of  purchases  over  sales,  i.e.,  the 
balance  of  each  card,  shows  the  value  of  that  line  of 
goods  on  hand,  and  the  total  of  the  balances  of 
all  cards  represents  the  cost  price  of  the  inventory.  If 
a  perpetual  inventory  is  not  maintained,  the  value  of 
the  stock-in-trade  must  be  ascertained  by  counting  and 
listing  the  various  items  of  merchandise  and  extending 
them  at  their  cost  price. 


202 


SIMPLE  JOURNAL  RECORDS 


6.    Operation  of  Purchases  Account 

The  cost  of  goods  sold  may  be  ascertained  by- 
debiting  Purchases  with  the  opening  inventory  and  the 
amount  of  current  purchases  as  taken  from  the  purchase 
journal,  and  crediting  it  with  the  closing  inventory.  In 
actual  practice,  however,  the  Purchases  account  is  more 
complicated  than  this.  Inward  freight  often  adds  to  the 
purchase  price  of  the  goods  and  is  clearly  a  charge  to 
their  cost.  Purchase  items  may  also  be  returned  to  the 
vendor  for  various  reasons  and  rebates  may  occasionally 
be  allowed  by  the  vendor.  These  should  be  deducted 
from  gross  purchases  to  arrive  at  net  purchases,  and 
therefore  are  credited  to  the  account.  For  the  recording 
of  such  transactions  separate  accounts  are  usually 
opened  under  the  heads  of  Inward  Freight,  Returned 
Purchases,  and  Purchase  Rebates  and  Allowances,  which 
are  debited  or  credited,  as  the  case  requires.  At  the 
close  of  the  fiscal  period  these  accounts  may  be  closed 
into  Purchases  account,  the  balance  of  which  then  re- 
veals the  cost  of  goods  sold,  as  here  shown : 

Purchases 


1918 

1918 

Dec.  31     Opening    Inven- 

Dec. 31 

Returned      Pur- 

tory,  July  1. . . 

$  9,675.00 

$  3,126.00 

58,721.50 

Rebates  and  al- 

Inward  Freight. 

1,860.75 

Closing  Inven- 
tory, Dec.  31.. 

Profit  and  Loss 
(Cost  of  Goods 
Sold  during  the 

520.70 
11,721.55 

54,889.00 

$70,257.25 

$70,257.25 

PURCHASE  RECORDS 


203 


The  transfer  of  the  balance  of  Purchases  account  to 
the  debit  of  Profit  and  Loss  account  for  the  purpose  of 
showing  the  gross  profit  for  the  period  has  been  dis- 
cussed in  Chapter  VIII.  All  that  is  necessary  here  is 
to  note  the  method  of  arriving  at  the  cost  of  goods  sold 
and  the  accounts  which  are  opened  to  collect  details  as 
to  freight  and  returns  and  allowances.  The  debits  and 
credits  to  these  accounts  are  given  in  Chapters  XXXVI 
and  XXXVII. 

The  Purchases  account  may  be  used  to  record  only 
the  net  cost  of  purchases  for  the  period.  In  that  case 
it  does  not  take  into  account  the  opening  and  closing 
inventories  and  is  debited  only  with  purchases  and 
freight-in  and  credited  with  returns  and  allowances.  Its 
balance  represents  the  amount  of  current  purchases  and 
is  closed  into  Trading  account  as  here  shown. 

Purchases 


1918 

Dec.  31     Purchases $58,721.50 

Inward  Freight.       1,860.75 


$60,582.25 


1918 

Dec. 

31 

Returned     Pur- 

$  3,126.00 

Rebates  and  Al- 

lowances   

520.70 

Net     Purchases 

for    period. . . 

56,935.55 

$60,582.25 


7.    Trading  Account 

This  account  is  a  subdivision  of  the  Profit  and  Loss 
account  and  is  used  only  at  the  end  of  a  period  when 
the  books  are  closed.  Its  purpose  is  to  show  the  gross 
profit  on  sales.  This  is  determined  by  debiting  Trad- 
ing account  with   (1)   the  opening  inventory   (ascer- 


204  SIMPLE   JOURNAL   RECORDS 

tained  by  a  physical  count  or  valuation),  and  (2)  the 
balance  of  Purchases  account ;  and  crediting  it  with  ( 1 ) 
the  closing  inventory  (ascertained  in  the  same  way), 
and  (2)  the  net  sales  of  the  period  as  shown  by  Sales 
account  to  be  described  in  Chapter  XIX.  The  opening 
inventory  plus  purchases  minus  the  closing  inventory, 
as  we  have  seen,  gives  the  cost  of  goods  sold;  and  sales 
minus  cost  of  goods  sold  gives  the  gross  profit.  This 
gross  profit  as  shown  below  is  transferred  to  the  Profit 
and  Loss  account. 

Trading  Account 


Opening   Inventory $9,675.00 

Purchases   56,935.55 

Profit    and    Loss    (Gross 

Profit)    15,000.00 


$81,610.55 


Closing   Inventory $11,721.55 

Sales   69,889.00 


$81,610.55 


The  Trading  account  as  described  shows  how  the 
gross  profit  is  ascertained,  and  the  Profit  and  Loss 
account  shows  the  expenses  of  administering  the  business 
while  the  gross  profit  was  being  earned. 

8.      Estimating  the  Inventory 

As  pointed  out  above,  the  inventory  of  goods  on 
hand  must  be  ascertained  by  physical  stock-taking  unless 
a  perpetual  inventory  record  be  maintained.  Stock- 
taking is  inconvenient  and  costly  and  thus  is  usually 
undertaken  only  once  or  twice  a  year.  Yet  an  approxi- 
mate inventory  at  other  times  may  be  exceedingly 
important  for  two  purposes:  (a)  to  establish  the  value 
of  goods  destroyed  by  fire  at  a  time  when  the  actual 


PURCHASE  RECORDS  205 

inventory  is  not  known,  and  (b)  to  make  possible  the 
determination  of  profit  or  loss  for  short  periods,  e.g., 
monthly,  between  times  of  stock-taking.  The  approxi- 
mate amount  of  the  inventory  can  be  ascertained  by 
using  the  estimated  percentage  of  gross  profit  in  the 
following  manner. 

Between  stock-taking  times,  the  books  usually  show 
the  last  inventory  taken,  purchases  since  that  time  at 
cost,  and  sales  during  the  period  at  selling  price.  If  the 
probable  percentage  of  gross  profit  is  known,  the  gross 
profit  can  be  estimated  by  applying  this  percentage  to 
the  amount  of  the  sales.  Subtracting  the  gross  profit 
from  the  sales  gives  the  cost  of  goods  sold.  It  is  evident, 
then,  that  the  inventory  can  be  approximately  ascer- 
tained by  subtracting  the  cost  of  goods  sold  from  the 
total  amount  of  goods  available  for  sale,  i.e.,  the  open- 
ing inventory  plus  the  purchases.  This  test  should  be 
applied  to  all  trading  accounts  to  disclose  any  errors  due 
to  incorrect  stock-taking. 

This  may  be  illustrated  by  using  the  Trading  ac- 
count shown  in  §  7 : 

Inventory  at  beginning  of  period $  9,675.00 

Purchases  during  period 56,935.55 

Total  Merchandise  available  for  sale $66,610.55 

Deduct  Cost  of  Goods  Sold: 

Sales    $69,889.00 

Less  Gross  Profit  (2ll/2%) 15,026.14  54,862.86 

Estimated  Inventory  at  end  of  period $1 1,747.69 


The  actual  inventory  shown  in  Trading  account  was 
$11,721.55. 


206  SIMPLE  JOURNAL  RECORDS 

REVIEW   QUESTIONS 

1.  What  is  the  function  of  a  purchase  journal  or  book? 

2.  What  advantages  accrue  from  keeping  a  Purchases  account  in 

the  ledger? 

3.  What  should  such  an  account  show? 

4.  Rule  a  purchase  book,  entering  therein  seven  transactions.   Then 

close  it. 

5.  Explain  how  the  amount  of  an  inventory  can  be  estimated. 


CHAPTER   XIX 
SALES    RECORDS 

1.  The  Function  of  the  Sales  Journal 

The  sales  journal,  sometimes  called  "Sales  Regis- 
ter," "Sales  Record,"  or  "Sales  Book,"  is  a  separate 
form  of  journal  designed  to  relieve  the  general  journal 
of  all  sales  transactions.  Entries  made  therein  show 
the  analysis  of  these  transactions  into  their  component 
elements  so  that  the  proper  accounts  may  be  debited 
and  credited. 

Comments  on  the  inadequacy  of  the  general  journal 
as  a  book  of  original  entry  for  recording  purchase  trans- 
actions are  equally  applicable  to  the  general  journal  as 
a  book  of  original  entry  for  sales  transactions.  The  use 
of  the  sales  journal  makes  it  possible  to  segregate  and 
post  in  summary  form  all  transactions  of  a  like  nature. 
One  credit  for  a  monthly  total  can  be  made  to  the  Sales 
account  in  the  ledger,  the  offsetting  debits  being  made 
currently  to  the  customers'  accounts  in  the  general 
ledger,  or  in  a  sales  ledger  if  one  is  maintained. 

2.  Form  of  Sales  Journal 

The  simplest  kind  of  sales  journal  is  identical  in 
form  with  the  purchase  journal  and  the  method  of  its 
operation  is  the  same  except  that  the  debiting  and  cred- 
iting are  reversed.  Individual  sales  are  debited  to  the 
accounts  with  the  customers  whose  names  are  entered  in 
the  explanation  space  but  only  one  credit  is  made  for 

207 


208 


SIMPLE  JOURNAL  RECORDS 


the  total  sales  at  the  end  of  the  month.    Following  is  a 
simple  form  of  sales  book. 


SALES  BOOK 

Accounts  to  be  Debited 

1918 
Oct. 

5 

10 
25 

28 

A.  Carpenter 
A.  Morton 
H.  Fox 
A.  Dix 

Sales  Account  Cr. 

$    400 
148 
841 
832 

00 
50 
30 
40 

$2,222 

20 

Form  4.   Sales  Book 

In  Chapter  XXIII  a  more  elaborate  sales  book  is 
shown  and  more  complex  transactions  are  recorded. 
In  the  present  chapter  attention  is  called  to  certain 
fundamental  characteristics  of  the  recording  of  sales 
regardless  of  the  form  of  the  sales  journal  and  the 
number  of  sales  accounts  carried  in  the  general  ledger. 

3.     Sales  Account 

The  purpose  of  the  Sales  account  is  to  show  the 
sales  for  the  period,  and  as  many  sales  accounts  may  be 
opened  as  there  are  lines  or  departments,  the  sales  of 
which  it  is  desired  to  record  separately.  At  the  close 
of  each  month  the  Sales  account  is  credited  with  the  total 
sales  for  that  month.  In  order  to  indicate  the  actual  or 
net  sales,  Sales  account  should  be  debited  with  returned 
sales  and  with  all  allowances  made  to  customers  except 
cash  discounts.  To  record  the  amount  of  returned  sales 
an  account  by  that  name  is  generally  maintained,  the 


SALES  RECORDS  209 

balance  of  which  may  be  transferred  to  the  debit  of  the 
Sales  account.  Likewise,  an  account  to  record  allow- 
ances to  customers  may  similarly  be  kept,  the  balance 
of  which  may  be  transferred  to  the  Sales  account.  The 
balance  of  the  Sales  account  will  then  represent  the  net 
sales  for  the  period  and  should  be  transferred  to  the 
Profit  and  Loss  account,  as  explained  in  Chapter  VIII. 

4.     Sales  to  Proprietor 

A  proprietor  often  will  withdraw  merchandise  for  his 
own  personal  use  and  the  accounting  for  such  with- 
drawals should  be  properly  handled.  If  they  are  ignored 
on  the  theory  that  the  proprietor  owns  the  merchandise 
and  thus  is  entitled  to  withdraw  it  for  his  personal  use, 
the  trading  results  will  not  be  correctly  stated  because 
the  cost  of  such  merchandise  has  been  included  in  the 
purchases  and  unless  credit  is  given  to  the  business  for 
the  merchandise  withdrawn  the  gross  profit  will  be 
understated.  The  easiest  way  to  record  such  with- 
drawals is  to  bill  them  in  the  regular  way  to  the  pro- 
prietor and  to  enter  the  sale  in  the  sales  journal  as  if 
it  were  one  to  a  customer.  The  debit  in  that  case  would 
be  made  to  the  proprietor's  drawing  account  instead  of 
to  a  customer's  account.  Generally  speaking,  there  is 
no  reason  why  the  proprietor  in  his  drawing  account 
should  not  be  charged  with  the  selling  price  of  the  mer- 
chandise. If,  however,  he  insists  upon  withdrawing  it 
at  cost,  the  most  exact  method  of  recording  the  with- 
drawal would  be  to  treat  it  like  a  returned  purchase. 
In  strict  accuracy  merchandise  withdrawn  at  cost  should 
not  be  credited  to  Sales  account  because  it  is  not  sold  at 
the  usual  selling  price  and  the  percentage  of  gross  profit 


210  SIMPLE  JOURNAL  RECORDS 

on  sales  will  be  understated  if  it  is  credited  to  sales. 
When,  however,  the  withdrawals  are  infrequent  and  the 
sales  are  numerous  it  is  entirely  practicable  to  enter  the 
withdrawals  as  sales  in  the  sales  j  ournal  notwithstanding 
the  fact  that  they  are  at  cost  price.  The  effect  of  such 
withdrawals  on  the  percentage  of  gross  profits  will 
usually  be  negligible. 

5.  Returned  Sales 

It  is  usually  impossible  to  avoid  the  return  of  mer- 
chandise by  customers  to  whom  it  has  been  sold.  Such 
returns  may  be  due  to  defects  which  were  not  noticed 
at  the  time  of  shipment  or  they  may  be  permitted  merely 
as  a  means  of  satisfying  a  customer's  whim  in  order  to 
retain  his  good-will.  For  whatever  reason  the  returns 
are  made  the  amount  should  be  clearly  indicated  in  the 
accounts.  If  returns  are  not  numerous  they  may  be 
entered  in  the  sales  journal,  the  figures  appearing  in 
red  ink  in  order  to  indicate  that  the  customer's  account 
will  be  credited  instead  of  debited  with  the  amount  of 
the  sale  which  was  returned.  Where  returned  sales 
are  numerous  a  separate  journal  or  a  separate  section 
of  the  sales  journal  should  be  provided  for  them.  The 
posting  and  the  other  bookkeeping  procedure  in  con- 
nection with  the  returned  sales  are  identical  with  those 
described  in  Chapter  XVIII  for  returned  purchases,  ex- 
cept, of  course,  that  the  debits  and  credits  are  reversed 
because  customers  instead  of  creditors  are  involved. 

6.  Significance  of  Turnover 

The  turnover  of  merchandise,  sometimes  called 
"stock  turn,"  signifies  its  sale  and  conversion  into  ac- 


SALES  RECORDS  211 

counts  or  notes  receivable  or  cash.  It  is  desirable  for 
the  proprietor  to  turn  over  his  merchandise  as  frequently 
as  possible  in  order  that  the  general  expenses,  such  as 
rent,  salaries,  and  the  like,  which  must  be  deducted  from 
the  gross  profit,  will  be  relatively  low.  Since  gross 
profit  is  the  excess  of  selling  price  over  the  cost  of  goods 
sold  it  does  not  depend  at  all  upon  the  element  of  time. 
If  the  same  volume  of  goods  can  be  sold  in  five  months 
instead  of  six,  the  gross  profit  would  be  the  same,  but 
in  the  latter  event  the  net  profit  is  greater  because  the 
general  expenses  which  depend  upon  the  element  of 
time  would  be  reduced  by  one-sixth.  This  fact  should 
be  realized  by  every  proprietor. 

Since  turnover  is  the  repeated  use  of  the  same 
capital  invested  in  changing  merchandise,  it  is  clear  that 
one  must  compare  the  inventory  (merchandise  available 
for  sale)  with  the  sales  (merchandise  which  has  been 
sold) .  It  is  clear  also  that  in  this  comparison  the  cost  of 
goods  sold  and  not  the  amount  realized  on  the  sales  must 
be  used  because  inventories  are  stated  at  cost  and  com- 
parison should  be  made  only  between  like  elements.  To 
compare  sales  at  selling  prices  with  inventory  at  cost  or 
vice  versa  would  be  meaningless.  In  order  to  calculate 
the  turnover  for  a  period,  the  cost  of  goods  sold  during 
the  period  should  be  divided  by  the  average  inventory 
on  hand  during  the  period.  Turnover  should  be  stated 
as  a  percentage  of  the  average  inventory  on  hand.  For 
example,  if  the  cost  of  goods  sold  was  $3,000  and  the 
average  inventory  $2,000,  the  turnover  would  be  150%. 
For  convenience  it  would  be  stated  as  1.5.  In  other 
words,  the  stock  has  been  turned  over  one  and  one-half 
times. 


212  SIMPLE  JOURNAL  RECORDS 

REVIEW    QUESTIONS 

1.  What  is  the  function  of  a  sales  record? 

2.  Describe  a  sales  record  and  show  its  relation  to  the  merchandise 

sales  account. 

3.  What  should  such  an  account  on  the  ledger  show? 

4.  Rule  a  sales  book  and   enter  therein   eight  sales  transactions. 

Then  close  it. 

5.  Show  the  relation  of  a  sales  record  to  the  journal. 


Part  IV 
Development  of  Journals 


CHAPTER   XX 

MISCELLANEOUS     CASH     MATTERS 

1.    Development  of  Modern  Cash  Book 

The  simple  form  of  cash  book  described  in  Chapter 
XVII  does  not  state  the  exact  truth  in  that  the  total 
receipts  may  be  inflated  by  the  amount  of  discounts  al- 
lowed customers  or  similar  items,  while  payments 
may  be  inflated  correspondingly  by  entering  on  the 
credit  side  items  which  are  merely  offsets  to  inflated 
debits.  Because  of  this  deficiency  such  a  record  is  in- 
adequate for  a  business  in  which  cash  transactions  are 
at  all  numerous  and  is  suited  only  to  the  most  elemen- 
tary type  of  bookkeeping.  To  meet  modern  accounting 
needs  a  more  elaborate  form  of  cash  book  is  required 
which  by  the  use  of  separate  columns  shows  total  re- 
ceipts and  payments,  the  discounts  received  and  allowed, 
if  any,  and  net  receipts  and  payments.  The  form  of 
such  a  cash  book  is  illustrated  below. 

As  will  be  seen,  by  examining  the  illustration,  the 
sum  of  the  discount  column  and  the  net  column  equals 
the  sum  of  the  sundries  column.  At  the  close  of  each 
month  the  footing  of  the  net  cash  column  should  be 
debited  to  the  Cash  account,  and  the  footing  of  the  dis- 
count column  posted  to  the  debit  of  Discount  on  Sales 
account.  The  items  in  the  sundries  column  are  sep- 
arately posted  to  the  credit  side  of  the  proper  ledger 
accounts.  At  the  close  of  each  month  the  footing  of  the 
net  cash  column  on  the  credit  side  should  be  credited  to 

215 


216 


DEVELOPMENT  OF  JOURNALS 


Dr. 


CASH 


Date 


1919 
July    l 

20 
21 
22 

28 
28 
29 


L.F. 


V 
104 

41 
181 
172 
101 
167 


Account  to  be  Credited 


Balance 

Cash  Sales 

Notes  Payable. 
A.  Johnson. . . . 

O.  Olp 

Cash  Sales. . . . 
O.  James 


Total   per  contra 

Deduct — Balance  July  1... 

Cash  Receipts 


Net  Cash 


$3,000.00 
193.28 
500.00 
334.92 
180.00 
88.36 
261.90 


$4,558.46 
3,000.00 


$1,558.46 


Discount 

on 

Sales 


$6.84 


8.10 


$14.94 


Sundries 


$3,000.00 
193.28 
500.00 
341.76 
180.00 
88.36 
270.00 


$4,573.40 


Form  5.    Cash  Book,  showing 

Cash  account.  The  footing  of  the  discount  column  on 
the  credit  side  is  credited  to  Discount  on  Purchases  ac- 
count. The  items  in  the  sundries  column  on  the  credit 
side  should  be  debited  to  the  proper  ledger  accounts.  As 
heretofore  noted,  all  receipts  entered  in  the  net  cash 
column  should  be  deposited  in  the  bank,  and  all  pay- 
ments entered  in  the  net  cash  column  should  represent 
checks  issued,  excepting  a  monthly  charge  for  exchange. 
Instead  of  the  single  discount  column,  as  shown  on 
the  form,  two  columns  for  deductions  may  be  maintained 
on  each  side  of  the  cash  book,  one  for  discounts  and 
another  for  interest;  but  this  is  seldom  necessary.    The 


MISCELLANEOUS  CASH  MATTERS 


217 


CASH 

Cr. 

Date 

Check 
No. 

L.F. 

Account  to  be  Debited 

Net 
Cash 

Discount 
on 
Purchases 

Sundries 

1919 

July  8 
11 
14 
17 
17 
21 
24 
24 
26 
29 
30 
30 

143 
144 

145 
146 

147 
148 
148 
149 
150 
151 
152 

61 

67 

80 

217 

62 

63 

50 

63 

210 

221 

64 

65 

2 

V 

V 

Printing  and  Stationery 
Insurance  

$     20.00. 

18.00. 

25.00. 

472.68. 

59. 

7.50. 

250.00. 

2.50. 

150.00. 

90.00 

98.50. 

50.00. 

$14.62 
7.89 

$     20.00 

18.00 

25.00 

487.30 

.59 

7.50 

250.00 

2.50 

157.89 

90.00 

98.50 

50.00 

A.  C.  Deacon 

H.   White 

F.    Sanders 

Rent    

$1,184.77. 
3,373.69. 

$22.51 

$1,207.28 

$4,558.46. 

Net  Receipts  and  Payments 

items  of  cash  discount  usually  occur  much  more  fre- 
quently than  interest,  so  that  the  column  for  deductions 
may  be  headed  "Discount."  In  case  a  note  is  dis- 
counted the  interest  deducted  may  be  entered  in  the  dis- 
count column  in  red  ink,  or  in  black  ink  with  the  abbre- 
viation "int."  written  at  the  side  of  the  amount.  At 
the  close  of  the  month,  the  footing  of  the  discount 
column  should  be  analyzed,  and  the  amount  of  interest 
items  and  discount  items  shown  separately  in  the  place 
where  the  single  footing  would  appear  if  there  were 
no  interest  items.  The  two  totals  should  then  be  posted 
separately. 


218  DEVELOPMENT  OF  JOURNALS 

2.    Exchange 

A  charge  for  exchange  when  out-of-town  checks  are 
deposited  in  the  bank  sometimes  causes  bookkeeping 
perplexity.  Such  a  charge  is  made  for  collecting  checks 
drawn  on  out-of-town  banks  and  range  from  1/10  to 
1/4  of  1  %  of  the  amount  of  the  deposited  check — with  a 
certain  minimum.  Exchange  charges  are  fixed  in  each 
locality  by  the  local  association  of  banks  known  as  the 
clearing  house.  Three  methods  of  making  the  charge 
to  the  depositor  for  this  service  are  in  general  use. 

The  first  method  is  to  deduct  the  exchange  from  the 
amount  of  the  deposited  check  and  to  enter  in  the  bank 
pass-book  only  the  net  amount  after  this  deduction. 
The  second  is  to  enter  in  the  pass-book  the  full  amount 
of  the  check  deposited,  but  to  keep  a  record  of  exchange 
charges  and  to  charge  the  depositor  with  the  total  at 
the  end  of  each  month.  This  charge  is  usually  effected 
by  the  bank's  reducing  the  depositor's  balance  and  noti- 
fying him  by  some  form  of  debit  memorandum,  the 
amount  of  which  is  generally  added  to  the  total  of  the 
depositor's  checks  paid  by  the  bank  and  returned  can- 
celed to  the  depositor.  A  third  method  is  to  allow  the 
depositor  to  pay  the  amount  of  the  exchange  when 
making  the  deposit.  Under  this  method  the  full  amount 
of  the  deposited  check  is  entered  in  the  pass-book  and 
no  charge  for  exchange  is  made  later. 

Upon  request  a  bank  will  generally  permit  a 
depositor  to  pay  exchange  at  the  time  of  deposit,  the 
exchange  charge  being  usually  paid  from  the  petty  cash 
fund.  This  method  is  recommended  as  the  simplest  and 
has  the  further  advantage  of  enabling  the  depositor  to 
prove  the  bank's  charge  at  the  time  it  is  made.    Under 


MISCELLANEOUS  CASH  MATTERS  219 

the  method  of  making  a  monthly  charge  in  total,  the 
depositor  must  either  accept  the  bank's  charge  as  cor- 
rect or  verify  it  by  a  detailed  examination  of  his 
deposits.  Such  an  examination  is  usually  laborious  and 
occasionally  puzzling.  If  either  the  first  or  second 
method  be  followed,  entries  must  be  made  in  the  cash 
book  to  record  the  exchange.  The  cash  book  should 
then  show  the  amount  of  the  receipt  before  any  deduc- 
tion for  exchange  because  the  debtor  is  usually  entitled 
to  credit  for  the  entire  amount  received,  the  exchange 
being  an  expense  to  be  borne  by  the  depositor;  hence, 
the  entry  for  the  exchange  should  be  made  on  the  pay- 
ments side  of  the  cash  book. 

3.    Exchanged  Checks 

Checks  which  are  exchanged  for  mutual  convenience 
have  nothing  in  common  with  the  bank  exchange  under 
discussion.  The  expedient  of  exchanging  checks  may 
be  used  for  extending  or  procuring  credit,  as  when  one 
of  the  checks  is  postdated  or  one  of  the  parties  to  the 
exchange  agrees  not  to  deposit  the  check  received  until 
some  later  time.  The  term  "exchanged  checks"  is 
applied  also  to  checks  drawn  for  cash  received  to  pro- 
vide the  person  to  whom  the  check  is  given  with  a  form 
of  credit  convenient  for  some  particular  use,  such  as 
transmitting  it  by  mail.  Sometimes,  in  the  collection  of 
an  account  receivable,  the  debtor  gives  a  check  drawn 
by  a  third  person  to  the  debtor's  order  for  an  amount 
larger  than  the  account  to  be  settled;  whereupon  a 
check  may  be  given  to  the  debtor  for  this  excess.  A 
check  drawn  for  this  excess  is  an  exchange  check  and 
that  received  from  the  debtor  should  be  so  designated 


220        DEVELOPMENT  OF  JOURNALS 

to  the  extent  of  the  excess  over  the  amount  of  the  ac- 
count which  is  settled. 

Although  exchanged  checks  do  not  affect  the 
balance  of  the  depositor's  account,  both  their  receipt  and 
payment  should  be  entered  in  the  cash  book  with  a 
sufficiently  complete  notation  of  the  facts  of  the  ex- 
change to  identify  the  transaction.  Such  an  entry  is 
necessary  to  provide  a  complete  record  of  deposits  made 
and  checks  drawn.#  The  record  would  be  particularly 
valuable  if  the  check  deposited  were  returned  by  the 
bank  as  worthless  or  if  the  check  given  in  exchange 
should  not  be  presented  for  payment  before  the  next 
balancing  of  the  account  by  the  bank. 

4.    Interest  on  Deposits 

An  item  which  requires  entry  on  the  receipts  side  of 
the  cash  book  is  interest  allowed  by  the  bank.  Many 
banks  allow  a  low  rate  of  interest  on  a  depositor's  ac- 
count when  the  amount  reaches  a  certain  size  prescribed 
by  the  bank.  For  example,  2%  per  annum  may 
be  allowed  on  every  daily  balance  of  $500  or  more; 
that  is,  for  every  day  when  the  depositor  has  at  least 
$500  in  the  bank  he  receives  interest  on  his  balance  at 
the  rate  of  2%  per  annum.  Incidentally  it  may  be 
mentioned  that  the  practice  of  most  banks  is  to  calcu- 
late this  interest  on  even  hundreds  only;  so  that  a 
balance  of  $499  draws  no  interest  and  a  balance  of  $599 
draws  interest  on  $500  only.  The  bank  generally  adds 
the  interest  to  the  depositor's  account  and  notifies  him 
by  noting  the  amount  of  the  interest  in  the  pass-book 
or  in  a  monthly  statement  submitted  to  him.  The  entry 
made  by  the  bank  is  usually  designated  as  interest  and 


MISCELLANEOUS  CASH  MATTERS  221 

thus  can  readily  be  distinguished  from  credits  for 
deposits.  A  similar  entry  must  be  made  in  the  cash 
book  and  included  in  the  total  receipts. 

5.    Notes  and  Drafts  Collected 

If  a  note  or  draft  has  been  taken  by  the  bank  for 
collection,  its  particulars  are  usually  entered  as  a 
memorandum  receipt  in  the  back  of  the  pass-book. 
After  the  note  or  draft  is  collected,  the  bank  adds  the 
amount  to  the  depositor's  account.  The  depositor  is 
usually  notified  of  the  collection  only  when  the  pass- 
book is  balanced  by  the  bank  or  when  he  receives  the 
next  monthly  statement  and  finds  the  amount  collected 
added  to  his  deposits.  It  is  the  practice  of  banks,  how- 
ever, to  notify  the  depositor  if  the  note  or  draft  is  not 
collected.  Consequently,  if  no  notice  of  non-collection 
is  received  at  the  maturity  of  the  instrument,  the 
depositor  may  assume  that  collection  has  been  made, 
but  he  should  confirm  this  by  inquiry  at  the  bank.  Upon 
confirming  the  collection  the  depositor  makes  an  entry 
of  the  amount  collected  in  the  cash  book  as  a  cash  re- 
ceipt. 

When  the  party  primarily  liable  on  a  note  or  draft 
left  at  a  bank  for  collection  fails  to  pay  it  at  maturity 
and  the  depositor  has  given  no  instructions  not  to  pro- 
test the  instrument,  the  bank  has  it  protested  and 
charges  the  protest  fees  to  the  depositor.  In  that  event 
the  only  entry  on  the  cash  book  is  for  the  protest  fees, 
and  whether  the  bank's  practice  is  to  require  a  check 
from  the  depositor  for  these  fees  or  to  deduct  them 
from  his  account  without  a  check,  the  depositor  should 
enter  them  on  the  payments  side  of  the  cash  book.    Pro- 


222  DEVELOPMENT  OF  JOURNALS 

test  fees  are  usually  chargeable  to  the  person  whose 
failure  to  pay  an  instrument  necessitated  the  expense 
of  the  protest ;  hence  the  entry  in  the  cash  record  should 
clearly  identify  the  instrument  and  name  the  person. 

6.  Deposits  Charged  Back 

Occasionally  an  item  deposited  is  returned  by  the 
bank  as  rejected.  The  most  common  example  is  a  cus- 
tomer's check  that  proves  to  be  worthless  and  is  con- 
sequently returned  to  the  depositor  by  his  bank,  which 
deducts  the  amount  from  his  account.  The  depositor 
should  then  enter  the  amount  of  the  returned  item  on 
the  credit  side  of  the  cash  book  so  as  to  include  it  in  the 
total  payments. 

This  procedure  is  preferable  to  that  of  deducting 
the  returned  check  from  the  total  receipts  shown  on 
the  cash  book,  partly  because  there  is  no  convenient  way 
of  making  subtractions  of  this  kind  and  partly  because 
the  receipts  shown  on  the  cash  book  should  agree  with 
the  deposits  shown  by  the  bank's  records.  If  subse- 
quently the  same  item  is  redeposited,  it  must  again  be 
entered  on  the  receipts  side  of  the  cash  book. 

7.  Notes  Paid  for  Depositor 

The  cash  book  should  contain  an  entry  of  every  note 
paid  by  the  bank  for  the  depositor.  Whenever  a  note 
payable  at  a  bank  is  executed  the  maturity  date  and 
the  amount  should  be  entered  in  some  collateral  record 
so  as  not  to  escape  attention.  At  the  maturity  of  the 
note  its  amount  including  interest,  if  any,  must  be  en- 
tered in  the  cash  book  as  a  payment.  The  general  prac- 
tice of  banks  is  to  pay  such  a  note  without  consulting 


MISCELLANEOUS  CASH  MATTERS  223 

the  maker  and  to  return  the  canceled  note  to  him  with 
the  interest,  if  any,  indicated  thereon,  when  his  paid 
checks  are  returned. 

8.  Bank's  Charge  for  Carrying  Account 

Banks  sometimes  charge  a  fee  for  keeping  an  ac- 
count whenever  its  balance  falls  below  a  specified 
amount.  For  example,  a  bank  may  charge  $1  a  month 
if  the  average  daily  balance  falls  below  $250.  Such  a 
fee  is  brought  to  the  attention  of  the  depositor  usually 
by  the  inclusion  of  a  debit  memorandum  with  the  paid 
checks  returned  by  the  bank.  Upon  receiving  notifica- 
tion of  the  charge  the  depositor  should  enter  the  amount 
in  the  cash  book  as  a  payment. 

9.  Void  Checks 

If,  for  any  reason,  a  numbered  check  is  made  void 
before  it  is  issued,  an  entry  should  be  made  in  the  cash 
book  showing  that  the  check  has  been  canceled.  This 
entry  is  advisable  in  order  to  account  for  all  numbered 
checks.  If  a  check,  after  it  is  issued,  is  returned  by 
the  payee  unaccepted,  as  for  instance,  when  a  payee 
claims  that  it  is  not  for  the  correct  amount,  the  cash 
book  should  include  the  returned  check  among  the 
receipts.  The  entry  for  the  returned  check  should 
identify  it  by  number  and  give  a  concise  statement  of 
the  reason  for  its  return.  The  amount  should,  of 
course,  be  credited  to  the  account  to  which  it  was  origin- 
ally charged.  If  no  record  be  made  of  it  except  by 
erasure  (which  is  always  bad  practice),  there  would  be 
no  indication  that  the  payee  had  returned  the  check 
though  business  relations  might  thereby  be  affected. 


224  DEVELOPMENT  OF  JOURNALS 

10.     Form  of  Bank  Statement 

The  following  form  is  typical  of  the  statements  used 
by  banks  in  large  cities  in  lieu  of  balancing  the  pass- 
books : 


Month  of  January,   1919 

CAMPBELL  &  JOHNSON,  INC. 

In  Account  With 

FIRST  NATIONAL  BANK 

Previous  balance  and  credits  listed  below $880.84 

Total  of  36  debits  per  machine  list  attached 542.50 

Feb.  1,  1919,  Balance  forward $338.34 

Please  examine  at  once.      If  no  error  is   reported  within  ten 
days  the  account  will  be  considered  correct. 
_ 

CREDITS    ONLY 


Date 

Item 

Amount 

Date 

Item 

Amount 

1919 

1919 

Jan.     1 

Balance 

$245.24 

Jan.  20 

$  21.25 

4 

11.50 

23 

35.00 

5 

22.00 

24 

47.00 

6 

10.00 

26 

54.50 

8 

5.00 

31 

17.10 

9 

113.00 

10 

42.00 

11 

43.00 

13 

64.00 

16 

116.00 

18 

34.25 

Please  call  for  your  statement  on  the  Second  Business  Day 
of  Each  Month  and  preserve  it  carefully,  using  Pass-Book  as 
Receipt  for  Deposits. 


Form  6.  Montlily  Bank  Statement 


MISCELLANEOUS  CASH  MATTERS  225 

In  the  above  form  the  debits  are  shown  in  total 
only;  but  the  number  of  debit  items  is  noted  on  the 
statement  and  they  are  listed  on  an  adding  machine  list 
which  is  submitted  with  the  statement.  The  debits 
referred  to  are,  of  course,  the  checks  drawn  by  the 
depositor  and  paid  by  the  bank,  which  are  returned  with 
the  statement  after  cancellation.  The  credits  listed  on 
the  bank's  statement  are  the  balance  at  the  beginning 
of  the  period  covered  by  the  statement  and  the  deposits 
made  during  the  period.  These  credits  will  be  identical 
with  the  entries  in  the  pass-book,  provided  that  every 
deposit  has  been  entered  therein.  Sometimes  deposits 
are  made  when  the  pass-book  is  not  available;  in  that 
case  a  receipt  in  the  form  of  a  duplicate  deposit  slip 
should  be  secured  from  the  bank.  These  slips  should  be 
destroyed  after  the  bank  has  credited  the  deposits  in  the 
pass-book  or  on  a  statement. 

Sometimes  a  more  elaborate  form  of  statement  is 
used  which  shows  the  checks  in  detail  with  the  dates  of 
their  payments  instead  of  merely  a  total  of  the  checks 
itemized  on  an  adding  machine  list. 

11.    Reconciling  Cash  Book  Balance  with  Bank  Balance 

Since  the  balance  of  cash  on  deposit  is  the  most  vital 
fact  shown  by  the  cash  book,  the  correctness  of  this 
balance  should  be  verified  regularly.  At  the  end  of 
each  month  the  state  of  the  account  as  shown  by  the 
bank's  records  should  be  ascertained  and  compared  with 
the  balance  shown  by  the  cash  book.  The  bank  will 
advise  the  depositor  as  to  the  amount  of  his  balance, 
either  by  sending  him  a  monthly  statement  or  by  noting 
the  balance  in  his  pass-book. 


226  DEVELOPMENT  OF  JOURNALS 

12.    Method  of  Reconcilement 

If  the  balance  at  the  end  of  the  fiscal  period  as 
shown  by  the  bank's  statement  is  not  identical  with  the 
balance  shown  by  the  cash  book,  the  two  should  be 
reconciled.  Only  in  this  way  can  the  balance  shown 
by  the  cash  book  be  verified.  The  reconcilement  forms 
no  part  of  the  cash  book  and  the  balance  shown  by  the 
bank  does  not,  as  such,  appear  thereon. 

The  canceled  checks  returned  by  the  bank  are 
examined  to  see  that  no  change  has  been  made  in  the 
amount  of  any  check.  If  all  receipts  have  been  deposited 
and  all  checks  issued  have  been  paid,  the  balance  in  the 
bank,  as  shown  by  the  bank  statement  or  by  the  pass- 
book, will  equal  the  balance  of  cash  on  hand,  as  shown 
on  the  cash  book.  If  all  checks  have  not  been  paid,  the 
amount  of  unpaid  checks  must  be  deducted  from  the 
bank's  balance  in  order  to  reconcile  the  balance  of  cash 
in  the  bank  with  the  balance  as  shown  by  the  cash 
book. 

The  bank's  statement  may  reveal  items  properly 
charged  or  credited  by  the  bank  which  have  not  been 
entered  on  the  cash  book,  as  interest,  exchange,  and  bank 
charges  for  maintaining  the  account.  If  such  items 
appear  on  the  statement,  the  necessary  corrections 
should  be  made  in  the  cash  book  at  once,  prior  to  making 
any  attempt  at  reconcilement.  Care  must  be  taken  to 
account  for  all  checks  shown  by  the  cash  book  as  issued 
during  the  month.  The  paid  checks  returned  by  the 
bank  may  run  numerically  without  a  break  and  yet  one 
or  more  of  the  last  checks  issued  during  the  month  may 
not  be  included  among  those  paid. 

When  a  reconciliation  has  been  accomplished,   a 


MISCELLANEOUS  CASH  MATTERS  227 

statement  thereof  should  be  entered  in  the  cash  book  in 
ink  in  any  available  space  near  the  entry  of  the  balance. 
Such  a  statement  should  be  substantially  in  the  follow- 
ing form,  care  being  exercised  to  show  the  number  of 
each  outstanding  check. 

RECONCILEMENT   WITH    BANK 

January  81,  1919 

Balance  per  cash  book $78.96 

Add — Outstanding  checks: 

#147  $28.50 

155  22.50 

162  7.75 

168  100.00 

164  100.00 

165  5.63  264.88 


Balance  per  bank $  388.84 


In  making  the  next  reconcilement  the  paid  checks 
returned  at  that  time  must  be  examined  to  ascertain 
whether  or  not  they  include  all  those  outstanding  at  the 
time  of  the  preceding  reconcilement.  If  not,  those  still 
unpaid  must  be  included  in  the  list  of  outstanding  checks 
used  to  reconcile  the  balance.  When  a  check  has  been 
outstanding  for  several  months,  the  matter  should  be  In- 
vestigated. If  the  check  has  not  been  received  by  the 
payee,  a  new  check  should  be  issued  and  entered  in  the 
usual  way.  Payment  of  the  lost  check  should  be  stopped 
by  an  order  to  the  bank  and  the  cash  book  adjusted  to 
show  cancellation  of  that  check,  as  explained  previously. 
Thereafter  the  canceled  check  should  not  be  counted  as 
outstanding. 


228       DEVELOPMENT  OF  JOURNALS 

13.  Bank  Columns  on  Cash  Book 

Sometimes  it  is  advisable  to  indicate  in  the  cash  book 
both  the  amount  of  the  bank  balance  and  the  cash  on 
hand  in  the  office,  although  it  is  rarely  desirable  for  the 
cash  book  to  record  anything  except  money  deposited 
in  the  bank.  Small  cash  payments  should  be  handled 
through  a  petty  cash  system  which  will  be  described 
later.  When  circumstances  are  such  that  it  is  necessary 
to  record  in  one  book  cash  on  hand  as  well  as  in  bank, 
a  bank  column  may  be  provided  on  each  side  of  the  cash 
book  to  show  deposits  and  checks  in  addition  to  columns 
for  cash  transactions.  When  there  is  more  than  one 
bank  account,  it  is  convenient  to  have  a  column  for  each 
bank  on  both  sides  of  the  cash  book  so  that  the  respective 
balances  may  be  indicated.  A  column  for  the  total  re- 
ceipts and  for  the  total  payments,  each  to  contain  both 
cash  and  bank  transactions,  should  also  be  provided. 

14.  Transfers  Between  Banks 

Where  the  cash  book  does  not  indicate  by  columns 
the  balance  on  deposit  in  each  bank,  a  transfer  from  one 
bank  to  another  should  be  recorded  as  a  memorandum 
or  as  a  debit  or  credit  to  ledger  accounts  with  the  banks 
affected.  When,  however,  cash  book  columns  are 
rifled  for  individual  banks  with  a  total  column  on  each 
side  for  the  total  deposits  and  total  checks,  a  transfer 
from  one  bank  to  another  should  be  recorded  in  the 
following  manner : 

Assuming  a  transfer  of  $100  from  Bank  A  to  Bank 
B,  the  amount  may  be  entered  in  red  ink  (in  order  that 
it  may  be  ignored  in  calculating  the  total  receipts)  on 
the  debit  side  of  the  cash  book  in  the  total  column.    The 


MISCELLANEOUS  CASH  MATTERS  229 

amount  should  be  entered  also  in  the  deposit  column 
for  Bank  B,  the  latter  entry  being  in  black  ink,  because 
there  has  been  an  actual  deposit  in  Bank  B.  The  entry 
in  the  total  column  is  needed  to  make  possible  a  proof  of 
the  footings  by  cross-footing  the  page  totals.  On  the 
credit  side  of  the  cash  book  the  amount  should  also  be 
entered  in  the  total  column  in  red  to  indicate  that  there 
has  not  been  an  actual  withdrawal  of  funds.  The 
amount  of  the  check  should  be  entered  in  black  ink  in 
the  Bank  A  column  because  an  actual  check  has  been 
drawn  on  that  bank. 

15.  Petty  Cash 

The  term  petty  cash  signifies  a  fund  of  currency 
kept  in  the  office  for  use  in  making  small  payments. 
Petty  cash  funds  are  used  in  practically  all  businesses 
and  vary  in  amount  with  the  demands  made  on  them. 
In  small  offices  the  fund  may  be  as  low  as  $5 ;  in  large 
offices  it  sometimes  exceeds  $1,000.  Whatever  its  size, 
the  record  of  the  fund  may  be  kept  most  conveniently 
by  the  method  proposed  below. 

The  record  of  petty  cash  is  frequently  neglected  be- 
cause of  the  relatively  small  amount  involved  and  be- 
cause of  ignorance  of  a  simple  method  of  recording  pay- 
ments.   Such  neglect  should  not  be  permitted. 

16.  Creation  of  the  Imprest  Fund 

The  first  requirement  of  any  adequate  petty  cash 
system  is  that  a  fund  shall  be  created  and  renewed 
only  by  duly  recorded  payments  from  the  general  cash. 
Money  received  by  the  business  should  not  be  added  to 
the  petty  cash  fund  but  should  be  deposited  in  a  bank. 


230        DEVELOPMENT  OF  JOURNALS 

Of  many  methods  of  handling  petty  cash,  the  following, 
known  as  the  "imprest"  method,  is  almost  always  to  be 
recommended. 

The  petty  cash  account  representing  the  fund  is 
debited  for: 

1.  The  amount  of  the  fund  created  to  meet  cur- 

rency disbursements. 

2.  The  amount  of  any  increase  if  the  fund  is  to  be 

increased. 

The  petty  cash  account  is  credited  for: 

1.    The  amount  of  any  decrease  if  the  fund  is  to  be 
decreased. 

The  balance  should  always  represent  the  amount  of  the 
imprest  fund. 

The  account  should  not  be  debited  or  credited  after 
the  fund  is  established  and  the  proper  amount  debited 
to  this  account,  except  when  the  fund  is  either  increased 
or  diminished.  The  contents  of  the  imprest  fund 
drawer  should  always  agree,  in  cash,  or  cash  and 
vouchers,  with  the  amount  of  the  fund  as  shown  by  the 
account  with  the  fund. 

No  payments  should  be  made  from  the  fund  except 
those  that  must  be  paid  in  currency.  Such  payments 
would  be  for  small  disbursements,  and  then  only  when 
a  check  would  not  be  practicable  or  acceptable  to  the 
payee.  The  pay-roll,  for  example,  should  never  be 
paid  from  this  fund. 

The  first  step  in  establishing  the  fund  is  to  draw  a 
check  adequate  to  meet  the  demands  upon  the  drawer 
for,  say,  one  month.     This  check  should  be  converted 


MISCELLANEOUS  CASH  MATTERS  231 

into  currency  and  this  currency  be  placed  in  a  drawer  or 
other  receptacle  to  be  used  for  the  imprest  fund  only. 
The  amount  should  be  charged  to  Petty  Cash  account. 

Each  currency  disbursement  from  the  fund  should 
be  supported  by  a  voucher,  and  be  recorded  in  the  petty 
cash  book.  At  the  close  of  the  period  determined  upon, 
or  when  the  fund  requires  replenishing,  a  check  should 
be  drawn  for  an  amount  equal  to  the  disbursements. 
This  will  bring  the  fund  up  to  the  original  amount. 
Whenever  the  fund  is  replenished  an  entry  should  be 
made  in  the  cash  book  charging  the  proper  accounts  as 
shown  by  a  summarized  analysis  of  the  disbursements, 
made  up  from  the  petty  cash  book.  The  vouchers 
should  be  filed  numerically,  according  to  months. 


REVIEW    QUESTIONS 

1.  (a)    Rule  a  cash  book  with  three  columns  on  a  side. 

(b)  Enumerate  the  advantages  to  be  secured  by  its  use. 

(c)  Describe  the  method  of  posting  from  such  a  book. 

2.  Describe  the  peculiarities  of  one  or  more  cash  books  with  which 

you  are  familiar. 

3.  Outline  in  detail  some  method  of  handling  cash  receipts. 

4.  The  cash  balance  for  our  cash  book  is  $3,350.     The  bank  balance 

per  the  bank  pass-book,  on  the  same  day,  is  $3,705.  Checks 
outstanding,  numbers  931,  932,  934,  953,  amount  respectively 
to  $96,  $152,  $52,  $55.  Reconcile  the  cash  book  balance  with 
the  bank  balance. 

5.  A  petty  cash  fund  of  $200  is  created.     Subsequently  the  follow- 

ing payments  are  made  therefrom:  postage  $40;  carfare  $3; 
office  supplies  $100;  stationery  $30.  Make  the  entries  neces- 
sary to  create  the  fund,  to  take  up  the  payments  made  there- 
from, and  to  close  out  the  fund,  restoring  the  cash  remaining 
therein  to  general  cash. 


CHAPTER    XXI 

MISCELLANEOUS    PURCHASE    MATTERS 

1.  Simple  Form  of  Modern  Purchase  Journal 

The  purchases  of  a  business  increase  in  volume  or 
variety  or  both  in  proportion  to  its  growth,  and  as  a 
means  to  successful  management  it  is  necessary  to  show 
the  purposes  for  which  purchase  expenditures  are  made. 
This  is  effected  by  dividing  the  business  into  depart- 
ments and  classifying  purchases  by  departments  so  far 
as  possible.  Thus  a  concern  which  buys  for  resale  will 
usually  base  the  departmental  division  of  the  business  on 
the  different  lines  of  goods  sold,  as  in  the  case  of  a  de- 
partment store.  A  manufacturing  concern  divides  its 
varied  activities  into  those  departments  the  cost  of  which 
it  is  desirable  to  record  separately  on  the  books.  This 
division  of  the  concern  into  a  number  of  smaller  busi- 
nesses, as  it  were,  necessitates  the  classification  or  segre- 
gation of  purchases  in  the  books  of  original  entry  so  far 
as  is  possible  by  departments.  Additional  columns  are 
then  needed  in  the  purchase  journal  to  show  the  monthly 
total  of  purchases  made  for  each  department.  The 
following  form  is  an  example  of  a  simple  type  of  journal 
in  which  purchase  expenditures  made  for  the  needs  of 
particular  departments  are  so  classified. 

2.  Fiscal  Periods 

In  the  study  of  the  following  form  the  first  feature 
to  be  noted  is  the  date  at  the  top,  "April,  1920."    The 

232 


MISCELLANEOUS  PURCHASE  MATTERS  233 

name  of  the  month  in  this  position  not  only  facilitates 
reference  but  it  also  serves  as  a  reminder  that  the  trans- 
actions for  each  month  must  be  entered  in  a  separate 
section.  Whenever  the  last  monthly  transaction  is  en- 
tered, the  total  to  that  point  must  be  ascertained  and  a 
new  page  opened  for  the  next  month's  transactions. 
There  is  no  logical  reason  for  selecting  one  month  as  a 
fiscal  period  but  in  the  majority  of  businesses  the  calen- 
dar month  is  a  convenient  length  of  time  for  the  accumu- 
lation of  statistical  figures  of  a  convenient  size  for  post- 
ing. 

3.    Terms 

In  the  column  headed  "Terms"  are  entered  the 
terms  for  cash  discount  applicable  to  each  invoice.  Cash 
discount  must  be  carefully  distinguished  from  trade 
discount,  which  is  a  subject  to  be  discussed  later.  At 
this  point  all  that  need  be  said  is  that  an  allowance  or  a 
reduction  in  the  amount  of  each  invoice  is  made  in 
accordance  with  the  terms  opposite  the  entry  if  such 
invoice  be  paid  in  the  time  specified.  For  example,  the 
item  of  Johnson  &  Giles  has  terms  of  2/10  n/30.  This 
means  that  if  the  account  is  paid  within  ten  days  2% 
may  be  deducted  from  it,  but  that  it  must  be  paid  "net" 
in  30  days.  It  is  desirable  to  have  the  terms  of  discount 
noted  in  both  the  purchase  journal  and  the  ledger  ac- 
count with  the  creditor. 

In  order  to  insure  the  payment  of  invoices  within  the 
discount  period  if  a  saving  can  be  thus  effected,  various 
filing  schemes  have  been  devised  to  bring  particular 
invoices  to  the  attention  of  the  management  on  the 
proper  days. 


234 


DEVELOPMENT  OF  JOURNALS 


PURCHASE 

Date 

Name  of  Creditor 

Terms 

L.  F. 

Amount 

Merchandise 

Dept.  A 

Dept.  B 

1920 
April     2 

2 

2 

3 

3 

3 

4 

1 

Duggan   &    Hopkins 

Century  Loft  Company. . 

2/10  n/30 
3/10  n/60 

701 
407 
500 
510 
515 
650 
690 

$  75.42 

100.00 

250.00 

50.00 

8.49 

342.78 

12.73 

$ 

100.00 

$50.00 

Meecham  &  Baker,  Attys 
N.  Y.  Central  R.  R.  Co. . . 

Cooper  &  Henderson.... 
Blandy   &   Tanner 

2/10  n/6C 

1 

Total    for   April 

$  3,786.3] 

V 

$949.80 
10 

$572.00 
12 

Form  7.   Purchase  Journal, 

4.    Analysis  Columns 

The  columns  to  the  right  of  the  amount  columns  are 
provided  so  that  purchases  may  be  analyzed  at  the  time 
of  their  entry  into  as  many  departmental  and  other  ac- 
counts as  are  required.  The  number  of  columns  and 
their  uses  in  a  particular  book  should  depend  partly 
upon  the  departmental  divisions  of  the  business,  partly 
upon  the  classification  of  accounts  desired  in  the  general 
ledger  and  also  upon  the  probable  frequency  with  which 
entries  will  be  made.    If  a  debit  to  any  one  account  is  of 


MISCELLANEOUS  PURCHASE  MATTERS  235 


JOURNAL 

April,  1920 

Purchases 

Freight 

Office 

General 

Sundries 

Dept.  C 

Dept.  D 

Inward 

Expense 

Expense 

Account 

L.F. 

Amount 

$25.42 

$ 

342.78 

$.... 
8.49 

<5 
12.73 

$ 

50.00 

Rent 

60 

$ 

250.00 

$341.66 
14 

$807.12 
16 

$16.57 
43 

$214.98 
47 

$70.00 
49 

$814.18 
V 

showing  Purchases  by  Departments 

rare  occurrence,  or  if  such  debits  during  a  month  do  not 
usually  exceed  three  or  four  in  number,  there  is  no  need 
for  a  separate  column  for  that  account.  Such  items  may 
be  entered  in  the  sundries  section  at  the  extreme  right  of 
the  above  form,  where  the  name  of  the  account,  the  folio 
on  which  it  appears  in  the  general  ledger,  and  the 
amount  of  the  debit  are  shown.  In  general  as  few  col- 
umns should  be  used  as  will  give  adequate  distribution. 
As  columns  increase  in  number,  the  danger  of  entering 
amounts  in  wrong  columns  also  increases. 


236        DEVELOPMENT  OF  JOURNALS 

5.  Expense  Accounts 

The  use  of  columns  for  expense  accounts  should  be 
noted.  While  the  title  of  the  book  seems  to  imply  that 
entries  should  be  restricted  to  purchases  of  merchandise, 
this  is  not  so.  Purchase  items  should  include  expenses 
such  as  freight  inward,  office  expense,  general  expense, 
and  sundries,  for  the  reason  that  the  purchase  journal 
serves  not  only  to  analyze  the  purchases,  but  also  to  list 
the  amounts  payable  to  creditors.  These  obviously 
comprise  payments  for  services,  such  as  insurance,  rent, 
etc.,  which  cannot  be  classified  as  merchandise  purchases, 
and  for  any  assets  bought  for  the  needs  of  the  business, 
such  as  equipment  and  office  furniture.  In  brief,  the 
purchase  journal  should  contain  a  record  of  all  expendi- 
tures on  credit,  and  the  debits  to  offset  these  credits 
should  be  so  classified  as  to  indicate  the  exact  account 
affected. 

6.  Folio  Columns 

The  folio  column  to  the  left  of  the  first  amount 
column  indicates  the  page  of  the  ledger  on  which  the 
creditor's  account  appears.  No  folio  columns  are  needed 
for  the  analytical  debit  columns  because  those  columns 
are  posted  in  total  to  the  ledger  accounts  designated  in 
each  heading,  as  will  be  explained  in  the  following 
section.  The  folio  column  in  the  sundries  section  indi- 
cates the  ledger  page  of  the  particular  account  to  be 
debited. 

7.  Monthly  Closing 

When  the  purchase  journal  is  closed  at  the  end  of 
the  month,  all  columns  are  added  and  their  totals  posted. 


MISCELLANEOUS  PURCHASE  MATTERS  237 

Since  each  item  has  been  credited  to  an  individual  credi- 
tor's account,  the  total  of  the  amount  column  need  not 
be  posted  unless  a  controlling  account  for  creditors  is 
kept,  as  explained  later.  The  only  debits  posted  in- 
dividually to  accounts  are  those  in  the  sundries  column. 
When  posting  the  columnar  totals  at  the  end  of  the 
month  the  total  merchandise  purchases  for  Department 
A  should  be  debited  to  an  account  so  entitled  and  like- 
wise the  totals  of  the  other  departmental  purchases. 
Freight  inward,  office  expense,  and  general  expense 
should  be  similarly  posted  to  accounts  with  those  titles. 
The  most  convenient  way  is  to  post  directly  from  the 
purchase  journal,  indicating  the  folio  under  the  amount 
at  the  foot  of  each  column. 

8.   Summary  Journal  Entries 

In  many  offices  it  is  customary  to  journalize  at  the 
close  of  each  month  the  various  totals  to  be  posted  to  the 
ledger  accounts  from  books  of  original  entry.  If,  for 
example,  it  was  required  to  make  a  journal  entry  of  the 
data  shown  on  the  accompanying  form,  the  entry  would 
be  drawn  up  as  follows : 

Merchandise  Purchases,  Dept.  A $949.80 

"      B 572.00 

"      C 341.66 

"      D 807.12 

Freight  Inward 16.57 

Office    Expense 214.98 

General  Expense 70.00 

Sundry  Debits  Posted  in  Detail 814.18 

Sundry  Credits  Posted  in  Detail $8,786.81 

A  journal  entry  of  this  kind  summarizes  and  con- 


238  DEVELOPMENT  OF  JOURNALS 

denses  the  information  covering  all  purchase  trans- 
actions during  the  month  and  at  the  same  time  insures 
that  the  proper  accounts  are  debited  and  credited.  Post- 
ings, however,  can  be  made  as  conveniently  and  with  a 
saving  in  clerical  work  directly  from  the  books  of  origi- 
nal entry. 

9.    Returned  Purchases 

In  almost  every  business  a  certain  portion  of  the 
goods  purchased  prove  defective  in  some  way  or  fail  to 
meet  the  requirements.  The  entry  recording  a  returned 
purchase  should  naturally  be  the  reverse  of  that  record- 
ing the  original  purchase,  the  general  journal  entry 
being  a  debit  to  the  creditor  and  a  credit  to  the  Pur- 
chases account.  Where  a  purchase  journal  is  used,  the 
returns  may  be  handled  in  one  of  two  ways.  If  few  in 
number,  they  may  conveniently  be  entered  in  the  pur- 
chase journal,  using  red  ink  instead  of  black  and  posting 
the  amount  to  the  debit  instead  of  to  the  credit  of  the 
creditor's  account.  The  red  ink  figures  in  the  distribution 
columns  are  to  be  deducted  from  the  total  of  the  black 
ink  figures  to  obtain  the  net  purchase  figures.  If  re- 
turns are  numerous,  it  is  usually  more  convenient  to 
enter  them  in  separate  sections  of  the  purchase  journal 
in  black  ink  in  the  ordinary  way.  Where  a  separate 
section  is  used,  the  returns  for  each  month  should  be 
totaled  in  the  same  way  as  the  purchases  for  each  month, 
but  the  postings  of  the  returns  should  naturally  be  made 
in  the  reverse  way.  Where  this  method  is  adopted  it  is 
advisable  to  keep  separate  purchase  returns  accounts 
in  the  ledger,  one  for  each  department  where  the  busi- 
ness is  departmentalized.    When  the  returns  are  entered 


MISCELLANEOUS  PURCHASE  MATTERS  239 

in  red  in  the  purchase  journal,  the  postings  to  Returned 
Purchases  account  can  be  made  conveniently  by  showing 
in  the  purchase  journal  two  totals  at  the  end  of  each 
month — one  for  the  black  figures  representing  purchases 
and  one  for  the  red  figures  representing  returns. 

10.     Development  of  Purchase  Journal 

The  simple  form  of  purchase  journal  discussed  in 
this  chapter  is  suited  to  the  needs  of  a  business  of 
moderate  size,  divided  into  not  more  than  half  a  dozen 
departments.  In  a  larger  business  with  a  great  variety 
of  purchase  transactions  the  ruling  shown  in  the  example 
would  prove  inadequate  for  the  classification  and  hand- 
ling of  many  varied  items,  and  the  adoption  of  more 
advanced  purchase  forms  and  methods  would  probably 
be  necessary.  Such  of  those  methods  as  are  used  in 
general  trading  or  manufacturing  accounting  will  be 
discussed  in  Volume  II.  The  fundamental  fact  to  be 
here  noted  is  that  purchases  should  not  be  entered  in  the 
general  journal  but  should  be  recorded  and  classified  on 
a  separate  journal  of  their  own. 


REVIEW    QUESTIONS 

1.  How  can  additional  columns  be  used  effectively  in  the  purchase 

book  ? 

2.  (a)   Prepare  a  ruling  for  a  purchase  book  to  provide  for  total 

monthly  charges  to  three  material  accounts  and  two  ex- 
pense  accounts,  and  also  to  detail   postings   to  sundry 
accounts, 
(b)   Describe  the  method  of  posting  from  such  a  book. 


CHAPTER    XXII 
THE    VOUCHER    SYSTEM 

1.  Inadequacy  of  Creditors  Ledger 

If  purchases  are  made  very  frequently  and  from 
constantly  changing  vendors,  and  if  each  invoice  is 
usually  paid  for  in  one  amount,  the  opening  of  a  ledger 
account  for  each  vendor  involves  unnecessary  clerical 
work  and  waste  of  ledger  pages.  In  practically  all  of 
these  accounts  there  will  be  one  or  two  credits  offset 
almost  immediately  by  a  debit  from  the  cash  book.  Fur- 
ther, as  accounts  increase  in  number,  it  becomes  difficult 
to  keep  them  so  that  any  one  of  them  can  be  found 
quickly.  If  a  bound  book  is  used,  one  of  unwieldy  size 
is  soon  required.  If  loose  sheets,  the  number  of  sheets 
increase  so  rapidly  that  the  filing  of  sheets  with  closed 
accounts  becomes  a  problem. 

2.  The  Voucher  System 

The  voucher  system,  with  which  this  chapter  deals, 
eliminates  individual  accounts  with  creditors  by  provid- 
ing a  record  of  payment  in  the  purchase  journal  itself. 
The  fundamental  feature  of  the  voucher  system  is  the 
elimination  of  creditors'  accounts.  This  is  accomplished 
by  providing  space  next  to  the  credit  item  in  the  pur- 
chase journal  in  which  to  note  its  payment.  Instead  of 
posting  the  credit  item  to  a  ledger  account,  it  remains 
in  the  purchase  journal  and,  when  paid,  the  fact  of  pay- 
ment is  noted  in  the  space  provided.    All  items  not  noted 

240 


THE  VOUCHER  SYSTEM  241 

as  paid  constitute  the  accounts  payable.  Thus  the  ledger 
feature  is  incorporated  in  the  purchase  journal,  and  the 
purchase  journal  then  becomes  a  voucher  register  or 
record.  A  form  of  voucher  record  is  shown  on  pages  244 
and  245,  recording  the  same  transactions  as  those  shown 
by  the  purchase  journal  in  Chapter  XXI. 

3.  Vouchers 

In  order  to  facilitate  the  handling  of  invoices  which 
vary  in  size  and  shape,  it  is  customary  to  have  voucher 
covers  to  which  invoices  can  be  attached.  A  sheet  8x9 
inches  folded  to  4  x  9  inches  is  a  convenient  size.  On  the 
back  of  the  cover  so  as  to  be  visible  when  the  cover  is 
folded,  it  is  customary  to  print  the  name  of  the  business 
and  to  provide  spaces  in  which  can  be  entered  the  name 
of  the  creditor,  the  date,  the  amount  due,  and  the  ac- 
counts to  be  debited.  Form  8  is  a  simple  example,  re- 
duced in  size. 

4.  Operation  of  Voucher  Record 

As  soon  as  invoices  have  been  approved  by  those 
responsible  for  the  receipt  of  materials  and  the  checking 
up  of  prices  and  calculations,  they  are  placed  inside  the 
voucher  covers  and  on  the  outside  is  entered  the  informa- 
tion for  which  space  is  provided  and  the  serial  number 
of  the  record.  The  cover,  together  with  the  invoices  and 
other  papers  supporting  the  creditor's  claim,  now  con- 
stitutes a  voucher  and  an  entry  is  then  made  in  the 
voucher  record,  or  register  as  it  is  at  times  designated, 
in  accordance  with  the  information  shown  on  the  cover. 
The  check  in  payment  of  the  invoice,  when  returned 
canceled  by  the  bank  at  the  end  of  the  month,  should  be 


242 


DEVELOPMENT  OF  JOURNALS 


VOUCHER   NO 

Hayes  and  Baylis 

in  favor  of 

$ 

191... 

Paid  by  Check  No 

"                      "         —Dept.  B 

—Dept.  C 

"                      "         —Dept.  D 

Office  Expense 

General    Expense 



Rent  

Salaries    . .' 

Total    

Goods  Received                                  Figures  Checked 

Prices  Checked                                   Approved  for  Payment 

Form  8.   Voucher  Folder 


attached  to  the  inside  of  each  voucher,  on  top  of  the 
invoice  or  other  papers.  In  this  way  the  evidence  of 
each  creditor's  claim  and  the  fact  of  its  payment  are 
preserved. 

After  a  voucher  is  entered  on  the  record  or  register, 


THE  VOUCHER  SYSTEM  243 

if  payment  is  to  be  made  immediately,  a  check  is  drawn 
and  issued.  Where  payment  is  not  immediate  but  ob- 
servance of  the  terms  of  credit  is  necessary  to  secure  a 
discount,  the  voucher  should  be  filed  away  in  a  tickler 
file  so  that  it  will  be  automatically  brought  to  atten- 
tion at  the  proper  time.  Upon  payment  of  the  voucher 
the  check  is  entered  in  the  cash  book  and  a  notation  is 
made  in  the  payment  column  of  the  voucher  record  of  its 
number  and  date. 

5.    Posting  from  the  Voucher  Record 

With  the  difference  that  no  postings  are  made 
to  a  creditors  ledger,  postings  from  the  voucher  rec- 
ord are  handled  in  precisely  the  same  way  as  from  the 
purchase  journal.  A  controlling  account  on  the  general 
ledger  showing  the  total  accounts  payable  controls  the 
voucher  record  and  makes  the  general  ledger  self -bal- 
ancing. This  controlling  account  is  variously  called 
"Accounts  Payable,"  "Vouchers  Payable,"  "Voucher 
Record,"  and  "Audited  Vouchers." 

In  the  example  given,  the  total  of  the  amount 
column,  $3,786.31,  should  be  credited  to  such  a  con- 
trolling account.  On  the  credit  side  of  the  cash  book  a 
column  is  provided  in  which  individual  payments  of 
vouchers  are  entered.  The  total  of  this  column  should 
be  debited  to  the  controlling  account  at  the  end  of  the 
month.  Payments  should  be  noted  in  the  voucher  record 
from  day  to  day  and  the  voucher  number  entered  in  the 
cash  book  to  perform  the  same  function  as  the  folio  of 
a  creditor's  account. 

If  this  procedure  be  followed,  at  the  end  of  each 
month  the  controlling  account  will  have  a  credit  balance 


244 


DEVELOPMENT  OF  JOURNALS 


April,  1920                                                                                           VOUCHER 

Vo. 
No. 

Date 

Name  of  Creditor 

Terms 

Amount 

Payment 

Merchandise 

Date 

Clik. 
No. 

.)ept.  A 

Dept.  B 

607 
608 
609 
610 
Cll 
C12 
CIS 

n 

2 
2 

3 
3 

4 

Johnson   &    Giles 

Duggan   &   Hopkin.... 
Century  Loft  Compan; 
Meecham  &  Baker,  Attys. 
N.  Y.  Central  R.  R.  Co. 
Cooper  &   Henderson . . 
Blandy   &   Tanner 

2/10  n/30 
3/10  n/60 

$  75.42 

100.00 

250.00 

50.00 

8.49 

342.78 

12.73 

4/11 

4/12 
4/2 

4/4 
4/13 

761C 

7628 
759C 

7600 
763C 

s) 

10Q.CO 

$50.00 

2/10  n/60 



Totals  for  April. 


1 3,786.3] 

IS 


$949.80 
10 


$572.00 
12 


Form  9. 


representing  the  liability  for  the  accounts  payable  as 
shown  by  the  voucher  record. 

6.    Proof  of  Controlling  Account  Balance 

At  the  end  of  each  month  the  controlling  account 
should  be  checked  or  proved  with  the  open  or  un- 
paid items  in  the  voucher  record.  The  usual  way  of 
proving  the  correctness  of  the  figures  is  to  list  the  open 
items  on  an  adding  machine  and,  after  the  total  has  been 
checked  as  correct,  to  note  thereon  the  numbers  of  the 


THE  VOUCHER  SYSTEM 


245 


RECORD 

Purchases 

Freight 
Inward 

Office 
Expense 

General 
Expense 

Sundries 

Dept.  C 

Dept.  D 

Account 

L.F. 

Amount 

$25.42 

$ 

342.78 

$.... 
8.49 

$ 

12.73 

$ 

50.00 

Rent 

60 

$ 

250.00 

1 

$341.66 

14 

$807.12 
16 

$16.57 

43 

$214.98 

47 

$70.00 
49 

$814.18 
V 

Voucher  Record 


vouchers  unpaid.    This  list  can  then  be  pasted  in  a  trial 
balance  book  as  a  permanent  trial  balance  record. 

7.  Unusual  Transactions 

Vouchers  are  not  always  canceled  by  payments  in 
cash.  Sometimes  a  creditor's  claim  is  settled  in  whole 
or  in  part  by  allowances  or  by  discounts;  or  sometimes 
by  the  exchange  of  merchandise  or  assets  other  than 
cash.  In  such  cases,  with  the  exception  of  cash  dis- 
counts, some  entry  is  required  other  than  one  in  the  cash 


246       DEVELOPMENT  OF  JOURNALS 

book.  If  a  voucher  is  canceled  by  a  journal  entry,  the 
entry  should  be  in  the  following  form: 

Vouchers    Payable $ 

To  account  originally  debited $ 

This  entry  has  the  effect  of  cancelling  the  one  originally 
made  in  the  voucher  record.  The  entry  should  show  the 
number  of  the  canceled  voucher  and  a  notation  should  at 
once  be  made  in  the  voucher  record  opposite  the  voucher 
number,  showing  the  fact  of  cancellation  and  indicating 
the  page  of  the  journal  in  which  the  entry  appears.  The 
journal  folio  is  entered  in  the  space  in  the  voucher  record 
for  the  check  number.  The  debit  to  the  controlling  ac- 
count must  be  a  separate  item  unless  the  journal  is 
provided  with  a  debit  column  for  accounts  payable.  In 
that  case  the  debit  items  may  be  entered  in  that  column, 
the  total  of  which  is  posted  at  the  end  of  the  month. 

Instead  of  paying  a  voucher  in  full,  payments  are 
sometimes  made  in  two  or  more  instalments.  In  order 
to  record  these  transactions  it  is  necessary  to  enter  each 
payment  of  cash  in  the  voucher  record,  entering  the  date 
and  check  number  for  each  instalment  in  small  figures. 
The  remaining  or  unpaid  balance  of  such  a  voucher 
should  then  be  noted  in  pencil,  generally  alongside  of  the 
payment  column,  so  that  in  listing  open  or  unpaid  items 
at  the  end  of  the  month  this  unpaid  balance  may  be 
included. 

The  last  example  indicates  a  limitation  of  the 
voucher  system  in  recording  partial  payments  or  pay- 
ments on  account.  In  such  a  case  ledger  accounts  are 
preferable.  Where,  however,  most  of  the  creditors' 
claims  can  be  handled  by  a  voucher  record,  only  a  few 
requiring   ledger   accounts,   ledger   accounts   may   be 


THE    VOUCHER    SYSTEM  247 

opened  for  these  few.    In  other  words,  a  combination  of 
the  two  systems  can  be  employed. 

8.    Voucher  Checks 

Because  of  the  risk  of  loss,  no  voucher  should  be  sent 
to  a  creditor  to  be  receipted  and  returned.  It  is  desir- 
able, therefore,  in  some  way  to  identify  on  the  check 
itself  the  voucher  which  the  check  pays.  Such  a  check 
is  known  as  a  voucher  check.  In  its  simplest  form  it 
consists  of  an  ordinary  check  on  which  is  stamped  suffi- 
cient information  to  identify  the  voucher.  A  convenient 
form  for  this  purpose  is  the  following,  for  which  a 
rubber  stamp  can  be  made : 

Indorsement  of  this  check  will  constitute  a  receipt  in  full 
for  the  following  items : 

Your  invoice  dated 19.. 

Our  voucher  No covering 


Instead  of  a  rubber  stamp  a  special  form  of  check  may 
be  used  which  has  printed  upon  it  much  the  same  in- 
formation as  indicated. 


REVIEW  QUESTIONS 

1.  State  briefly  the  uses  and  limitations  of  the  voucher  system. 

2.  (a)   Give  headings  for  a  voucher  record  suitable  to  any  business 

with  which  you  are  acquainted, 
(b)   Describe  the  method  of  posting  from  such  a  book. 


CHAPTER    XXIII 

MISCELLANEOUS     SALES     MATTERS 

1.  Analytical  Form  of  Sales  Record 

The  same  observations  apply  to  the  division  of  sales 
into  departments  as  are  applicable  to  the  purchases  of 
a  business.  To  secure  the  desired  classification  of  sales, 
as  many  columns  must  be  ruled  in  the  sales  journal  as 
there  are  classes  of  goods,  the  sales  of  which  are  to  be 
shown  separately  on  the  books.  The  form  presented  on 
pages  250  and  251  is  adequate  for  a  moderate  sized 
business  where  the  transactions  are  not  especially  com- 
plicated. The  illustrative  entries  and  the  following 
comments  will  explain  its  underlying  feature  so  that 
modifications  of  the  form  may  be  introduced  to  meet 
varying  conditions. 

2.   Monthly  Period;   Terms  and   Folios 

The  desirability  of  securing  a  monthly  total  of  pur- 
chases has  been  emphasized,  and  the  same  is  applicable 
to  sales.  The  terms  of  sale  are  as  important  as  the  terms 
of  purchase  and  should  be  treated  in  the  same  way  in 
the  sales  journal  as  in  the  purchase  journal.  Customers 
frequently  deduct  discounts  to  which  they  are  not  en- 
titled, and,  unless  the  terms  of  sale  are  clearly  entered 
in  the  journal  and  noted  in  the  customer's  account,  an 
unauthorized  deduction  for  discount  may  be  overlooked. 
The  use  of  the  folio  columns  is  identical  with  that  in  the 
purchase  record  and  requires  no  further  comment. 

248 


MISCELLANEOUS  SALES  MATTERS  249 

3.  Sales   Number 

The  sales  may  conveniently  be  numbered  and  en- 
tered numerically.  This  provides  reasonable  certainty 
that  none  of  them  will  be  overlooked.  Where  the  records 
are  not  properly  designed  and  operated,  it  is  not  uncom- 
mon to  find  a  sale  completely  omitted  from  the  books, 
resulting  often  in  a  loss  of  the  amount  involved  in  the 
transaction. 

4.  Charge  Sales 

The  items  in  the  charge  sales  column  are  debited 
individually  to  personal  accounts  with  customers.  Off- 
setting credits  are  handled  in  the  same  way  as  those  in 
the  purchase  journal.  The  total  of  each  column  relating 
to  department  sales  is  credited  to  a  Department  Sales 
account  and  the  folio  is  noted  under  the  total  to  indicate 
the  fact  that  it  has  been  posted.  In  the  sundry  sales 
section,  the  use  of  which  will  be  discussed  later,  items  are 
credited  individually  to  their  proper  accounts,  so  that 
the  total  of  that  column  does  not  need  to  be  posted.  A 
verification  of  the  correctness  of  the  additions  in  the  sales 
journal  can  be  obtained  by  ascertaining  that  the  total 
of  the  charge  and  cash  sales  columns  equals  the  sum 
of  the  totals  of  all  the  other  columns. 

5.  Cash  Sales 

In  the  illustrative  form  sales  are  primarily  classified 
under  the  heads  of  "cash"  and  "charge"  sales,  this  being 
a  convenient  division  for  those  businesses  in  which  cash 
sales  are  made  over  the  counter.  To  determine  the  total 
sales  of  each  department,  it  is  necessary  to  combine  cash 
and  charge  sales.     Cash  sales  are  entered  in  the  sales 


250 


DEVELOPMENT  OF  JOURNALS 


April,  1920 

SALES 

Sales 
No. 

Date 

Name 

Terms 

L.  F. 

Amount  of  Sale 

Charge 

Cash 

782 
783 
784 
785 
786 

1920 
April  1 

1 

1 

1 

o 

Burton    &    Co 

2/10  n/30 

M 

2/20  n/60 

201 

217 

207 

V 

241 

$115.00 
281.64 
996.37 

52.58 

$ 

Blaisdell  &  Anson 

Jenson  &  Bro 

Cash  Sales  for  Day 

196.11 

Wilson    &    Babage 

Net 

Totals   for  April. 


1,017.82 

V 


$831.96 

V 


Form   10.    Sales  Journals 


journal  and  distributed  in  the  columns  provided  therein, 
because  to  provide  such  columns  for  their  analysis  in  the 
cash  book,  as  would  be  necessary  if  cash  sales  were  to  be 
analyzed  separately,  would  entail  duplication  of  effort. 
Accordingly,  to  avoid  this  duplication,  cash  sales  are 
entered  in  the  sales  journal  and  distributed  in  the  col- 
umns provided  therein. 

It  is  important,  however,  to  enter  the  total  of  the  cash 
sales  in  a  separate  column.  If  a  controlling  account  for 
accounts  receivable  were  maintained,  as  will  be  explained 
in  Chapter  XXIV,  it  would  be  necessary  to  secure  the 
total  of  the  charge  sales  for  posting  to  that  account ;  but 


MISCELLANEOUS  SALES  MATTERS  251 


JOURNAL 

Dept. 
A 

Dept. 
B 

Dept. 
C 

Dept. 
D 

Sundry  Sales 

Article 

L.F. 

Amount 

$115.00 
47.18 

$ 

250.00 

32  09 

$ 

996.37 
100.50 

$ 

31.64 

16.34 

98 

$ 

52.58 

Containers 

$1,092.34     $916.11 

100                  102 

$888.71 
104 

$1,900.04 
106 

$52.58 
V 

showing  Sa 

les  by  De] 

)artments 

even  if  no  such  controlling  account  is  kept,  time  and 
effort  will  be  saved  by  listing  the  total  of  the  cash  sales  in 
a  separate  column.  It  will  be  noticed  that  an  entry  is 
made  only  of  the  total  cash  sales  for  the  day.  It  is  un- 
necessary to  duplicate  the  individual  items  of  such  sales 
in  this  book,  as  they  already  appear  in  the  cash  records. 
The  total  of  the  cash  sales  column  may  be  debited  at 
the  end  of  the  month  to  Cash  Sales  account  in  the  gen- 
eral ledger.  This  debit  and  those  to  individual  cus- 
tomers offset  the  credits  to  the  various  sales  accounts. 
If  such  a  Cash  Sales  account  be  used,  it  should  be 
credited  at  the  end  of  each  month  with  the  total  cash 


252        DEVELOPMENT  OF  JOURNALS 

collections  from  cash  sales.  This  latter  figure  can  be 
secured  from  the  cash  receipts  record  which  should  be 
provided  with  a  separate  column  in  which  cash  sales  may 
be  entered.  It  is  evident  that  the  Cash  Sales  account 
will  have  no  balance  at  the  end  of  the  month  because  no 
sale  is  entered  as  a  cash  sale  unless  the  cash  is  at  once 
received;  consequently,  the  entries  for  the  daily  totals 
made  in  the  sales  journal  will  exactly  equal  the  sum  of 
the  collections  entered  in  the  cash  record.  Thus  the 
debit  to  the  Cash  Sales  account  from  the  sales  journal 
will  exactly  equal  the  credit  to  that  account  from  the 
cash  book.  From  this  it  follows  that  the  Cash  Sales  ac- 
count in  the  ledger  may  be  omitted.  In  that  event, 
neither  the  debit  from  the  sales  book  nor  the  credit  from 
the  cash  book  would  be  posted. 

6.  Sundry  Sales 

Under  the  head  of  "sundries"  are  included  items 
which  cannot  be  readily  classified  under  the  department 
headings.  In  the  illustrative  example  a  sale  of  con- 
tainers is  recorded.  Any  sale,  even  of  a  fixed  asset,  can 
usually  be  recorded  most  conveniently  in  the  sales  jour- 
nal because  this  is  the  logical  medium  for  posting  the 
sale  to  the  debit  of  the  purchaser.  Sales  of  such  items 
should  not  be  credited  to  the  sales  accounts  because  these 
accounts  are  designed  to  show  the  regular  trading  sales 
in  each  department.  The  credit  for  each  miscellaneous 
or  sundry  sale  should,  of  course,  be  made  to  the  account 
which  records  the  asset  sold. 

7.  Sales  to  Proprietor 

When  merchandise  is  withdrawn  for  the  personal  use 


MISCELLANEOUS  SALES  MATTERS  253 

of  the  proprietor  the  accounting  for  such  merchandise 
should  be  so  handled  that  trading  results  will  not  be 
affected  by  such  withdrawals.  The  easiest  way  to  record 
such  personal  use  of  merchandise  is  to  bill  it  to  the 
proprietor  in  the  regular  way.  If,  however,  the  proprie- 
tor insists  on  withdrawing  goods  at  cost,  the  most  accu- 
rate method  of  recording  the  withdrawal  is  to  treat  it  as 
a  credit  to  purchases.  Such  merchandise  should  not  be 
credited  to  sales  because  it  is  not  sold  at  the  usual  selling 
price  and  the  gross  profit  will  be  understated  if  it  be  so 
included.  If  these  sales  are  infrequent,  they  may  be 
passed  through  the  sales  journal,  since  their  effect  upon 
the  gross  profit  will  be  negligible. 

8.  Containers 

Containers  of  all  kinds,  boxes,  barrels,  bags,  etc., 
frequently  present  an  annoying  accounting  problem. 
Problems  connected  with  their  proper  accounting  under 
peculiar  circumstances  will  not  be  considered  in  this 
volume.  The  simplest  case,  which  is  the  one  presumed 
in  the  illustrative  entry,  is  when  a  container  is  sold  out- 
right— usually  to  a  junk  dealer.  In  this  case,  a  Con- 
tainers account  would  be  credited  with  the  amount 
realized  on  such  sale.  Care  should  be  exercised  not 
to  include  sales  of  containers  in  the  general  sales. 

9.  Freight  Outward 

Where  the  invoice  to  a  customer  includes  a  definite 
charge  for  freight  outward,  the  goods  being  sold  f.  o.  b. 
store,  it  is  obvious  that  the  freight  should  be  credited 
not  to  the  Sales  account,  because  it  does  not  represent 
a  sale  of  merchandise,  but  to  a  separate  account,  Freight 


S54        DEVELOPMENT  OF  JOURNALS 

Outward.  A  column  may  be  provided  in  the  sales  jour- 
nal for  such  freight  and  the  amount  thereof  entered  in 
that  column. 

10.  C.  O.  D.  Sales 

A  C.  O.  D.  sale  must  be  delivered  before  the  cash 
is  received  and  considerable  time  may  elapse  between 
the  shipment  and  the  receipt  of  the  money  to  be  col- 
lected. Consequently,  some  method  needs  to  be  pro- 
vided to  record  such  sales  so  that  they  will  not  be  over- 
looked. When  numerous,  a  column  should  be  allotted 
to  them  similar  to  that  for  cash  sales  and  a  column  in  the 
cash  book  should  also  be  used  for  collections.  Conse- 
quently, a  C.  O.  D.  sales  account  will  be  debited  from  the 
sales  journal  and  credited  from  the  cash  book,  the  bal- 
ance being  a  debit  representing  the  outstanding  and 
uncollected  shipments. 

11.  Returned  Sales 

If  returned  sales  are  few  in  number,  they  may  be 
entered  in  red  in  the  sales  journal.  In  such  case  the 
customer's  account  will  be  credited  instead  of  debited, 
if  a  charge  sale  be  returned.  If  a  cash  sale  be  returned 
the  figure  may  still  be  entered  in  red  in  the  cash  sales 
column  and  the  same  figure  should  be  charged  to  cash 
sales  on  the  credit  side  of  the  cash  book.  Where  red 
figures  are  used,  they  may  be  deducted  from  the  total 
of  the  black  figures  in  the  distribution  columns  or 
those  columns  may  show  two  totals — one  in  black  for 
the  sales  and  one  in  red  for  the  returns.  The  posting 
and  other  bookkeeping  procedure  in  connection  with 
returned  sales  is  identical  with  that  described  for  re- 


MISCELLANEOUS   SALES    MATTERS  255 

turned  purchases  except,  of  course,  that  the  debits  and 
credits  for  a  returned  sale  will  be  the  reverse  of  those 
for'  a  returned  purchase.  Where  returned  sales  are  nu- 
merous, a  separate  journal  or  a  separate  section  of  the 
sales  journal  should  be  provided  for  their  entry. 

12.    Special   Forms   and   Methods 

In  a  large  business  where  transactions  are  com- 
plicated, the  form  of  sales  journal  herein  described  may 
be  inadequate.  Special  forms  for  the  recording  and  the 
billing  of  customers'  orders  as  filled  must  be  provided 
and  suitable  methods  of  bookkeeping  in  connection  with 
sales  should  be  designed.  In  Volume  II  of  this  series 
such  special  methods  and  forms  will  be  described. 


KEVIEW  QUESTIONS 

1.  How  can  additional  columns  be  used  effectively  in  the  sales  book? 

2.  (a)    Prepare  a  ruling  for  a  sales  book  to  provide: 

Total  monthly  postings  to  three  goods  accounts. 
The  separation  of  cash  sales  from  charge  sales, 
(b)   Describe  the  postings  from  such  a  record. 


PartV 
Miscellaneous  Accounting  Topics 


CHAPTER   XXIV 
CONTROLLING    ACCOUNTS 

1.  Introductory 

A  controlling  account  is  kept  in  the  general  ledger 
and  is  one  which  controls,  i.  e.,  summarizes,  a  number  of 
other  accounts  usually  kept  in  a  separate  ledger,  by- 
showing  in  its  balance  the  net  amount  of  the  balances 
of  all  the  controlled  accounts.  These  latter  are  known 
as  subsidiary  accounts,  and  the  ledger  in  which  they  are 
kept  is  called  a  subsidiary  ledger.  The  use  of  a  con- 
trolling account  presents  no  difficulties  provided  the 
reason  for  its  existence  is  understood,  and  no  other  ex- 
pedient in  double-entry  bookkeeping  is  so  fundamen- 
tally useful. 

2.  Arrangement  of  Accounts 

Instead  of  accounts  being  arranged  indiscriminately, 
regardless  of  their  classification,  it  is,  as  explained  in 
Chapter  VI,  far  more  convenient  to  arrange  them  so 
that  in  the  trial  balance  the  accounts  that  are  grouped 
together  will  indicate  in  a  general  way  the  vital  facts 
concerning  the  business.  Asset  accounts  other  than  ac- 
counts receivable  should  be  in  one  section  of  the  ledger, 
expense  accounts  in  another,  income  accounts  in  an- 
other, accounts  payable  in  still  another,  and  other  ac- 
counts should  be  similarly  grouped. 

It  is  evident  that  all  accounts  in  the  ledger  must  be 
considered  in  the  trial  balance,  regardless  of  the  scheme 

259 


260         MISCELLANEOUS  ACCOUNTING  TOPICS 

of  classification  by  which  ledger  accounts  are  grouped. 
If  a  single  account  or  any  group  of  accounts  were  omit- 
ted from  the  trial  balance,  equilibrium  would  be  impos- 
sible. As  heretofore  stated,  a  Cash  account  is  not  al- 
ways kept  in  the  ledger,  in  which  case  the  amount  of 
cash  as  shown  by  the  cash  book  must  be  included  in  the 
trial  balance.  The  safer  and  better  practice,  however, 
is  to  make  the  ledger  self -balancing  by  including  in  it 
cash  and  all  other  accounts. 

3.    Advantages  of  Controlling  Accounts 

In  a  large  business,  the  inconvenience  and  risk  of 
error  due  to  having  a  great  many  accounts  in  one  ledger 
may  be  avoided  by  dividing  the  accounts  into  various 
groups,  opening  a  separate  ledger  for  each  group  and 
substituting  in  the  general  ledger  one  controlling  ac- 
count for  each  group  of  accounts  removed  to  a  subsidiary 
ledger. 

The  advantages  of  controlling  accounts  may  be 
enumerated  as  follows : 

1.  They  make  possible  the  use  of  loose-leaf  sub- 
sidiary ledgers.  Where  the  customers  of  a  business  are 
frequently  changing  and  the  sales  to  each  are  infrequent, 
it  is  generally  better  to  keep  their  accounts  in  a  loose-leaf 
ledger.  By  this  means  accounts  which  are  closed  may  be 
taken  out  of  the  ledger  and  filed  in  a  transfer  binder,  and 
those  which  remain  can  be  grouped  alphabetically,  geo- 
graphically, or  by  departments.  The  form  of  loose-leaf 
ledger  depends  entirely  upon  the  requirements  of  the 
particular  business  in  which  it  is  to  be  used.  Cards  are 
frequently  employed  and  prove  satisfactory,  except  for 
the  risk  of  removal.  If  card  ledgers  are  used,  the  credit 


CONTROLLING  ACCOUNTS  261 

department,  salesmen,  and  all  other  persons  in  the  organ- 
ization, including  the  administrative  heads,  must  be  cau- 
tioned not  to  remove  cards  from  the  ledger  for  any  pur- 
pose whatever.  If  a  statement  of  a  customer's  account 
is  needed  to  facilitate  correspondence  with  him,  the 
statement  should  be  provided  by  the  bookkeeping  de- 
partment but  the  customer's  ledger  card  should  not  leave 
the  file. 

2.  Controlling  accounts  facilitate  the  division  of 
work  among  several  employees.  It  is  unusual  to  find  a 
business  where  all  the  accounting  can  be  done  by  one 
bookkeeper  or  clerk.  When  subsidiary  ledgers  are  em- 
ployed it  becomes  possible  to  assign  bookkeepers  to  dif- 
ferent ledgers,  thereby  facilitating  the  work  and  helping 
to  fix  the  responsibility  for  errors. 

3.  Controlling  accounts  make  possible  the  quick 
preparation  of  financial  statements.  When  the  general 
ledger  is  once  in  balance  it  may  be  assumed  to  be  cor- 
rect even  before  subsidiary  ledgers  are  balanced.  State- 
ments of  financial  condition  can  thus  be  prepared  with- 
out waiting  for  the  proof  of  accounts  receivable  or  ac- 
counts payable  or  other  subsidiary  ledgers.  Moreover, 
statements  can  be  sent  to  customers  as  soon  as  the  sub- 
sidiary ledger  for  accounts  receivable  is  shown  to  be 
correct  even  though  the  general  ledger  may  be  out  of 
balance. 

4.  The  use  of  controlling  accounts  is  a  great  aid  in 
localizing  errors  revealed  by  a  trial  balance.  As  each 
subsidiary  ledger  is  proved  to  be  in  agreement  with  its 
controlling  account,  it  may  at  once  be  eliminated  in  a 
search  for  a  difference.  When  the  difference  is  finally 
located  in  one  ledger,  either  general  or  subsidiary,  the 


262         MISCELLANEOUS  ACCOUNTING  TOPICS 

search  may  be  confined  to  that  specific  section  of  the 
work. 

When  the  accounts  in  a  ledger  run  to  several  hun- 
dred or  more,  as  is  frequently  the  case  in  a  business  of 
any  size,  the  task  of  drawing  off  a  monthly  trial  balance 
becomes  burdensome.  If  at  the  first  attempt  it  does 
not  balance,  the  search  for  the  "difference"  is  likely  to 
be  laborious  and  irritating.  If  more  than  one  book- 
keeper is  employed,  to  fix  responsibility  for  errors  be- 
comes increasingly  difficult  and  the  whole  of  the  book- 
keeping staff  may  be  penalized  by  overtime  work  for  the 
error  of  an  individual  employee.  Statements  to  be  ren- 
dered to  customers  and  financial  statements  for  office 
use  cannot  safely  be  prepared  until  the  ledger  is  in  bal- 
ance, and  in  other  ways  a  trifling  clerical  error  may  seri- 
ously disorganize  the  routine  of  a  large  office.  Current 
work  is  sometimes  so  delayed  by  trial  balance  difficulties 
that  it  becomes  exceedingly  troublesome  and  entails 
much  overtime  work  to  bring  the  records  up  to  date. 

4.    Opening  of  Controlling  Accounts 

Since  a  controlling  account  represents  in  its  balance 
the  net  amount  of  all  balances  of  accounts  in  a  sub- 
sidiary ledger,  it  is  obvious  that  the  way  to  open  a  con- 
trolling account  is  to  withdraw  from  the  general  ledger 
the  accounts  that  are  to  be  placed  in  a  subsidiary  book, 
substituting  in  their  place  the  one  controlling  account. 
By  so  doing  the  general  ledger  is  left  in  balance,  al- 
though the  number  of  accounts  therein  is  reduced  by 
those  transferred  to  the  subsidiary  ledger.  The  open- 
ing of  a  controlling  account  should  invariably  be  made 
by  a  journal  entry. 


CONTROLLING  ACCOUNTS  263 

5.    Journal  Entry  to  Open  Controlling  Accounts 

The  journal  entry  required  to  open  a  controlling 
account  may  be  made  in  a  two-column  journal,  but  it 
is  better  to  have  a  columnar  journal  with  a  debit  and  a 
credit  column  for  each  ledger  used.  If  a  general  ledger, 
an  accounts  payable  ledger,  and  an  accounts  receivable 
ledger  are  used,  a  six-column  journal  should  be  em- 
ployed with  two  columns  for  each  ledger.  The  use  of 
such  journals  is  explained  in  Volume  II. 

In  a  two-column  journal  the  entry  to  open  a  con- 
trolling account  should  show  a  debit  or  a  credit  to  the 
controlling  account  which  equals  the  net  amount  of  the 
debit  and  credit  balances  in  the  detail  accounts  which 
are  to  be  transferred.  Assume  for  illustration  the  open- 
ing of  a  controlling  account  for  accounts  receivable, 
some  of  which  have  credit  balances,  due  to  overpay- 
ments and  credits  for  returned  sales.  The  first  step  in 
the  preparation  of  the  opening  journal  entry  is  to  de- 
termine the  exact  balances  of  all  customers'  accounts 
to  be  transferred.  An  entry  should  then  be  made  debit- 
ing a  controlling  account  which  may  be  called  "Accounts 
Receivable"  with  the  net  of  all  the  balances,  debiting 
also  any  customers'  accounts  which  contain  credit  bal- 
ances and  crediting  all  other  accounts  with  customers. 
The  posting  of  such  a  journal  entry  to  the  accounts  in 
the  general  ledger  needs  no  explanation.  The  final  re- 
sult is  to  eliminate  from  the  general  ledger  all  cus- 
tomers' accounts  and  to  substitute  a  single  controlling 
account  in  their  place. 

The  subsidiary  accounts  receivable  ledger  should 
now  be  opened  and  an  account  provided  therein  for  each 
customer  as  recorded  in  the  journal  entry.    The  same 


264         MISCELLANEOUS  ACCOUNTING  TOPICS 

journal  entry  may  be  used  for  posting  to  the  subsidiary 
ledger,  care  being  taken  to  debit  each  customer's  ac- 
count in  that  ledger  with  the  same  amount  that  was 
credited  to  his  account  in  the  general  ledger.  Although 
the  customers'  accounts  in  the  general  ledger  may  be 
numerous,  the  journal  entry  as  suggested  above  should 
nevertheless  be  made.  Balances  ought  not  to  be  trans- 
ferred from  one  ledger  to  another  except  through  the 
medium  of  the  journal.  The  reason  for  this  is  that  if 
the  subsidiary  ledger  accounts  should  later  prove  to  be 
out  of  balance,  there  will  be  no  certainty  that  the  open- 
ing balances  were  correctly  transferred. 

6.    Devices  to  Save  Work 

In  order  to  avoid  the  task  of  writing  each  customer's 
name  and  balance  in  the  journal — a  task  of  considerable 
size  if  such  accounts  run  into  hundreds — the  following 
procedure  is  suggested:  The  balances  of  the  accounts 
to  be  transferred  may  be  listed  on  an  adding  machine. 
The  correct  total  will  then  be  assured  and  the  adding 
machine  list  may  itself  be  pasted  in  the  journal.  The 
name  of  each  customer  can  then  be  noted  on  the  adding 
machine  list  opposite  to  the  balance  in  his  account,  and 
postings  can  be  made  both  to  the  credit  of  the  cus- 
tomer's account  in  the  general  ledger  which  is  to  be 
closed  and  to  the  debit  of  his  account  in  the  new  ledger 
which  is  to  be  opened.  Only  a  sufficient  notation  need 
be  made  on  the  list  to  identify  the  account.  This  prac- 
tice saves  time,  insures  the  correctness  of  the  addition, 
and  economizes  space  in  the  journal  since  the  adding 
machine  slip  may  be  cut  into  proper  lengths  so  that  three 
or  four  widths  may  be  pasted  on  one  journal  page. 


CONTROLLING  ACCOUNTS  265 

7.  Current  Entries 

The  operation  of  controlling  accounts  requires  that 
in  each  book  of  original  entiy  a  column  be  allotted  to 
each  controlling  account.  The  individual  amounts  to  be 
debited  or  credited  to  separate  accounts  in  the  subsidiary 
ledger  are  entered  in  their  proper  columns  and  then 
added  and  posted  in  total  at  the  end  of  the  month  to  the 
controlling  account  affected.  If  each  item  which  is 
posted  to  an  account  in  a  subsidiary  ledger  were  also 
to  be  posted  in  detail  to  the  controlling  account,  prac- 
tically no  advantage  would  be  gained  by  having  such  an 
account  and  much  needless  duplication  of  work  would 
result.  Accordingly  the  postings  to  controlling  ac- 
counts from  each  book  of  original  entry  should  be  in 
monthly  totals,  care  being  taken  to  include  in  those 
totals  every  item  posted  in  detail  to  any  account  in  the 
subsidiary  ledgers.  It  is  obvious  that  the  balance  of  the 
controlling  account  will  not  agree  with  the  balances  in 
the  subsidiary  ledger  unless  every  item  entering  into  the 
subsidiary  ledger  is  in  some  way  included  in  the  con- 
trolling account  and  vice  versa. 

8.  Posting  to  Subsidiary  Ledgers 

In  the  discussion  of  the  cash  book  in  Chapter  XXVI, 
a  column  on  the  debit  side  of  that  book  for  accounts 
receivable  and  one  on  its  credit  side  for  accounts  payable 
will  be  pointed  out  as  necessary  to  utilize  controlling 
accounts. 

To  take  accounts  receivable  as  an  example,  every  re- 
ceipt of  cash  from  a  customer  should  be  credited  from 
the  cash  book  to  his  individual  account  in  the  accounts 
receivable  ledger.    At  the  end  of  each  month  the  total 


266         MISCELLANEOUS  ACCOUNTING  TOPICS 

of  the  accounts  receivable  column  can  then  be  posted 
to  the  credit  of  the  controlling  account.  By  this  means 
every  item  which  has  been  credited  to  an  account  in  the 
subsidiary  ledger  will,  in  effect,  by  being  included  in  the 
total,  be  credited  to  the  controlling  account. 

9.    Accounts  Receivable  Ledger 

It  will  be  remembered  that  the  sales  book  suggested 
in  Chapter  XXIII  contained  a  column  for  charge  sales. 
Continuing  the  example  of  accounts  receivable,  every 
item  entered  in  that  column  of  the  sales  book  should  be 
debited  to  a  customer's  account  in  the  accounts  receiv- 
able ledger.  Since  the  total  of  the  charge  sales  column 
at  the  end  of  each  month  is  to  be  posted  to  the  debit  of 
the  controlling  account  in  the  general  ledger,  it  is  evi- 
dent that  every  item  posted  to  the  debit  of  any  account 
in  the  subsidiary  ledger  is  in  effect  posted  to  the  debit 
of  the  controlling  account. 

Where  journal  entries  affecting  controlling  accounts 
are  numerous,  two  columns  of  the  j  ournal  should  be  pro- 
vided for  each  controlling  account,  as  explained  above. 
Accounts  receivable  are  frequently  affected  by  journal 
entries  for  unusual  allowances  which  cannot  conve- 
niently be  handled  in  a  return  sales  book,  as  suggested 
in  Chapter  XXIII.  Every  item  which  is  entered 
in  the  journal  to  the  debit  or  credit  of  an  account 
receivable  should  be  posted  to  such  account  in  the  sub- 
sidiary ledger  and  the  total  of  each  of  the  columns 
in  the  journal  in  which  such  items  appear  should 
be  posted  at  the  end  of  each  month  to  the  debit 
or  credit  of  the  controlling  account  as  the  case  may 
require. 


CONTROLLING  ACCOUNTS  267 

10.  Accounts  Payable  Ledger 

The  purchase  book  discussed  in  Chapter  XXI  con- 
tained a  column  for  amounts  due  to  individual  credi- 
tors. When  a  controlling  account  is  maintained  for  ac- 
counts payable,  the  individual  postings  and  the  posting 
of  the  monthly  total  from  the  purchase  book  are  made 
in  the  same  way  as  similar  postings  from  the  other  books. 

11.  Frequency    of    Posting;     Subsidiary    and     General 

Ledgers 

All  detail  postings,  from  whatever  book  of  original 
entry,  which  affect  individual  accounts  in  subsidiary 
ledgers,  should  be  made  daily,  so  that  if  a  customer  or  a 
creditor  desires  to  know  his  balance  it  may  be  given  to 
him  instantly.  The  posting  at  the  end  of  the  month 
should  be  confined  solely  to  the  total  affecting  the  con- 
trolling account.  From  this  it  follows  that  during  the 
month  the  controlling  account  will  not  give  any  infor- 
mation disclosing  the  condition  of  the  subsidiary  ledger. 
It  is  not  necessary  that  it  should.  The  advantages  of 
a  controlling  account  lie  in  the  agreement  with  its  sub- 
sidiary ledger  at  the  end  of  each  month. 

12.  Unusual  Entries  in  Controlling  Accounts 

In  the  foregoing  description  of  the  use  of  controlling 
accounts  only  the  ordinary  and  customary  transactions 
have  been  considered.  Some  entries,  however,  are  un- 
usual and  a  column  for  the  collection  of  their  monthly 
totals  cannot  always  be  conveniently  provided.  Such 
transactions  must  be  posted  in  detail  to  the  controlling 
account  at  the  same  time  that  the  posting  is  made  to  the 
individual  or  subsidiary  account. 


268         MISCELLANEOUS  ACCOUNTING  TOPICS 

An  example  of  such  an  unusual  transaction  would  be 
the  receipt  of  cash  from  a  creditor  to  adjust  an  overpay- 
ment. Such  an  item  should  appear  on  the  debit  side  of 
the  cash  book  and  would  be  posted  to  the  credit  of  the 
individual  creditor's  account.  As  ordinarily  there  is  no 
column  on  that  side  of  the  cash  book  for  accounts  pay- 
able, the  item  must  at  once  be  credited  to  the  controlling 
account.  Failure  to  observe  this  simple  requirement 
would,  of  course,  throw  the  books  out  of  balance. 

13.    Monthly  Trial  Balances 

If  postings  have  been  properly  made  to  controlling 
accounts,  the  general  ledger  will  be  in  balance  at  the  end 
of  the  month.  Each  subsidiary  ledger  should  then  be 
proved  by  listing  its  balances  and  seeing  that  their  net 
amount  agrees  with  the  balance  in  the  controlling  ac- 
count. The  expression  "net  amount"  of  these  balances 
is  used  advisedly.  While  most  of  the  balances  of  a  sub- 
sidiary ledger  are  on  the  same  side — all  credits  or  all 
debits — occasionally  a  balance  is  found  on  the  opposite 
side.  For  example,  a  customer's  account  may  contain  a 
credit  balance,  or  that  of  a  creditor  may  show  a  debit 
balance  because  of  some  unusual  transaction.  Such  bal- 
ances must,  of  course,  be  deducted  from  the  sum  of  the 
usual  balances  in  order  to  determine  the  net  balance 
which  will  agree  with  that  of  the  controlling  account. 
A  credit  balance  in  a  customer's  account  could  result 
from  an  inadvertent  overpayment  by  him  or  from  a 
credit  for  returned  goods  which  had  been  accepted  either 
because  the  goods  were  defective  or  because  the  custom- 
er's good-will  could  be  preserved  only  by  allowing  the 
credit.    A  debit  balance  in  an  account  payable  could  re- 


CONTROLLING  ACCOUNTS  269 

suit  from  an  overpayment  or  from  a  return  of  goods 
purchased  after  they  had  been  paid  for. 

The  subsidiary  ledger,  therefore,  is  not  self-balanc- 
ing, practically  all  of  its  balances  being  on  one  side.  To 
call  a  list  of  the  balances  in  a  subsidiary  ledger  a  "trial 
balance"  is  hardly  accurate  in  the  strict  sense  of  this 
term,  although  it  is  customary  in  accounting  termi- 
nology to  designate  such  a  list  as  a  trial  balance. 

14.    Controlling  Account  in  Subsidiary  Ledger 

A  subsidiary  ledger  may  be  made  self -balancing  by 
the  following  expedient:  Therein  an  account  can  be 
kept  which  will  be  exactly  the  reverse  of  its  controlling 
account  in  the  general  ledger.  The  same  monthly  post- 
ings and  the  same  incidental  postings  for  unusual  trans- 
actions which  are  made  in  the  controlling  account  in  the 
general  ledger  may  at  the  same  time  be  made  in  reverse 
— debits  for  credits  and  vice  versa — in  this  new  account 
in  the  subsidiary  ledger.  Such  an  account  could  be 
called  a  controlling  account  for  the  general  ledger.  Its 
operation  makes  the  subsidiary  ledger  self-balancing. 

It  is,  however,  rarely  advisable  to  use  such  an  ac- 
count when  all  the  bookkeeping  is  done  in  one  office,  as 
no  purpose  is  served  that  is  not  equally  well  served  by 
the  controlling  account  on  the  general  ledger.  The 
practice  has  one  element  of  danger  in  that  it  gives  the 
bookkeeper  who  is  responsible  for  the  subsidiary  ledger 
an  opportunity  to  force  his  balance ;  which  means  to  re- 
port falsely  in  order  to  make  his  ledger  appear  to  be  in 
balance.  A  bookkeeper  in  charge  of  a  subsidiary  ledger 
should  be  required  to  report  its  trial  balance — using  the 
phrase  as  explained  in  the  preceding  section — in  igno- 


270         MISCELLANEOUS  ACCOUNTING  TOPICS 

ranee  of  the  figure  with  which  it  must  agree.  Thus  he 
has  no  means  of  knowing  in  advance  whether  or  not  his 
trial  balance  is  correct  and  there  will  be  no  temptation 
to  misstate  his  balances  to  avoid  overtime  work. 

15.    Extension  of  Controlling  Account  Principle 

Controlling  accounts  are  most  commonly  used  for 
accounts  receivable  and  accounts  payable.  They  may, 
however,  be  employed  in  any  case  where  it  is  desired  to 
relate  one  ledger  definitely  to  another  which  must  be 
self-balancing.  Controlling  accounts  thus  are  used  in 
branch  office  accounting  where  ledgers  kept  in  different 
offices  form  integral  parts  of  the  accounting  system; 
they  are  used  in  cost  accounting  where  separate  ledgers 
are  kept  to  show  the  progress  of  work  in  the  factory; 
and  another  example  of  their  use  is  in  connection  with 
private  ledgers. 


REVIEW  QUESTIONS 

1.  What  general  rule  should  govern  the  order  in  which  the  accounts 

should  be  arranged  where  only  one  ledger  is  operated  in  a 
small  business  ? 

2.  Does  any  advantage  attach  to  the  employment  of  more  than  one 

volume  for  the  ledger  of  a  business  requiring  only  one  book- 
keeper?    Give  reasons. 
8.    (a)   What  is  the  purpose  of  controlling  accounts  ? 

4.  What  do  you  understand  by  a  self-balancing  purchase  ledger? 

Describe  fully  the  method  of  keeping  it. 

5.  From  the  data  presented  in  the  illustrative  proposition  in  Chapter 

XVI,  construct  a  creditors'  controlling  account,  proving  the 
figures  of  same  against  the  ledger  accounts  as  there  presented. 

6.  Rule  a  cash  book  to  provide  for  controlling  accounts  of  debtors 

and  creditors. 


CHAPTER    XXV 
TRADE  DISCOUNT  AND  CASH  DISCOUNT 

1.    Discounts  in  General 

A  discount  is  an  allowance  or  rebate  to  reduce  the 
nominal  price  of  anything.  Commercial  discounts  may 
be  divided  into  two  main  groups.  The  first  consists  of 
deductions  made  from  list  or  catalogue  prices  when  an 
article  is  sold.  Such  discounts  are  really  a  part  of  the 
bartering  or  trading  which  precedes  the  fixing  of  the 
real  or  actual  price.  Trade  discounts  come  within  this 
classification. 

The  second  kind  of  discount  is  an  allowance  for 
prompt  payment  after  the  purchase  price  has  been 
definitely  fixed  and  the  sale  made,  and  is  known  as  a 
"cash  discount."  The  rebates  said  to  have  been  allowed 
by  railroads  to  shippers,  which  have  been  held  to  be 
illegal,  belonged  to  the  second  general  class.  In  business 
many  items  are  allowed  in  reduction  of  the  price  of 
goods  sold  which  are  not  strictly  cash  discounts.  Such 
items,  although  strictly  cash  discounts,  are  commonly 
designated  as  "allowances." 

2.    Trade  Discount 

Trade  discounts  are  allowed  as  a  reduction  from  a 
catalogue  or  list  price,  either  to  avoid  printing  new  cata- 
logues whenever  prices  fluctuate  or  to  provide  a  ready 
means  for  fixing  prices  in  unusual  cases.  An  example 
of  the  latter  procedure  is  that  of  a  sale  to  a  customer 

271 


272         MISCELLANEOUS  ACCOUNTING  TOPICS 

who  is  given  an  exceptionally  favorable  price  either  be- 
cause of  his  credit  standing  or  because  of  the  volume  of 
his  business. 

3.  Method  of  Stating  Trade  Discount 

Trade  discounts  are  usually  cumulative.  This  means 
that  they  consist  of  two  or  more  percentages  the  first 
of  which  is  deducted  from  the  catalogue  or  list  price,  the 
second  from  the  balance  left  after  the  deduction  of  the 
preceding  percentage,  and  so  on.  For  example,  a  trade 
discount  may  be  expressed  as  15-10-7.  This  would  be 
calculated  by  first  deducting  15%  from  the  list  price; 
then  10%  from  the  balance;  and  finally  7%  from  the 
second  balance.  Assuming  the  list  price  to  be  $100,  the 
final  selling  price  would  be  $71.15. 

Because  these  percentages  are  cumulative,  the  order 
in  which  they  are  stated  does  not  matter.  A  discount  of 
50:30-10  equals  that  of  10-30-50  or  any  other  order  of 
these  rates. 

4.  Quick  Methods  of  Calculation 

In  the  example  given  of  15-10-7,  these  rates  are 
known  as  "percentages  off"  because  they  are  to  be  taken 
off  the  list  price.  The  remaining  percentages  of  85-90- 
93  are  known  as  "percentages  on."  The  problem  in 
calculating  any  trade  discount  is,  of  course,  to  arrive  at 
the  final  price,  which  will  be  a  certain  percentage  of  the 
list  price.  If  the  discount  were  but  one  percentage,  for 
example  15%,  the  selling  price  would  be  85%  and  it 
could  be  determined  by  calculating  the  "percentage  on" 
of  85.  If,  however,  there  are  three  percentages  to  be 
deducted,  the  final  "percentage  on"  can  be  determined 


TRADE  DISCOUNT  AND  CASH  DISCOUNT       273 

by  multiplying  together  the  three  percentages  on  and 
using  the  product  as  the  final  percentage  on.  In  the  ex- 
ample given  those  percentages  are  85-90-93.  The 
product  of  these  three  percentages  is  71.145  and  this  is 
the  final  "percentage  on"  which  will  give  the  actual 
price.  Assuming  the  list  price  to  be  $100,  the  actual 
price  will  be  $71.15  as  stated  in  the  preceding  section. 

Where  the  transactions  involving  trade  discount  are 
numerous,  tables  can  be  prepared  showing  the  final  per- 
centage on  for  all  the  usual  combinations.  Such  a  table 
consists  of  a  series  of  columns  giving  the  usual  discount 
rates  and  showing  in  one  column  the  final  percentage  on, 
by  use  of  which  the  actual  price  can  be  calculated  after 
the  various  percentages  have  been  deducted.  Such  a 
table  makes  possible  the  quick  and  accurate  checking  of 
invoices  to  which  trade  discounts  are  applicable. 

A  single  discount,  if  it  be  a  factor  of  100,  can  be 
calculated  most  quickly  by  dividing  the  list  price  by  the 
other  factor.  For  example,  if  the  discount  is  12%%,  it 
can  be  more  quickly  calculated  by  dividing  by  8  than  by 
multiplying  by  12%  and  dividing  by  100. 

5.    Factors  and  Reciprocals 

In  order  to  understand  the  preceding  rule,  some 
reference  to  elementary  arithmetic  must  be  made.  A 
factor  is  one  of  two  or  more  quantities  which  when  mul- 
tiplied together  produce  a  given  quantity.  For  ex- 
ample, the  factors  of  24  are  6  X  4,  or  2  X  3  X  4,  or 
2X3X2X2.  If  two  factors  multiplied  together  pro- 
duce 1  they  are  called  reciprocals.  Examples  of  these 
are  .5  and  2;  .125  and  8.  In  the  case  of  reciprocals, 
multiplying  by  one  of  them  is  equivalent  to  dividing  by 


274         MISCELLANEOUS  ACCOUNTING  TOPICS 

the  other.  This  can  be  demonstrated  as  follows  by  ap- 
plying the  reciprocals  .5  and  2  to  the  quantity  8: 

8  X  5  =  4 
8  -=-  2  =  4 
8X2      =16 

8  -f-     .5  =  16 

The  same  rule  holds  true  if  the  reciprocals  produce  100 
instead  of  1,  the  only  difference  being  in  the  placing  of 
the  decimal  point.  Thus,  if  the  discount  rate  is  a  factor 
of  100,  the  discount  can  be  calculated  by  dividing  by  the 
other  factor. 

6.  Incidental  Use  of  Reciprocals 

Reciprocal  tables  showing  all  reciprocals  up  to  sev- 
eral decimal  places  can  be  purchased.  Such  tables  can 
be  conveniently  used  in  conjunction  with  an  adding  ma- 
chine upon  which  multiplication  can  be  easily  performed 
but  with  which  it  is  difficult  to  divide.  Where  much 
division  has  to  be  done,  as  in  calculating  percentages  on 
statements,  the  result  can  be  quickly  obtained  by  finding 
in  the  table  the  reciprocal  of  the  divisor  and  multiplying 
by  that  amount. 

7.  Trade  Discount  in  the  Accounts 

Trade  discount  does  not  enter  into  the  bookkeeping 
and  accounting  of  a  business  because  it  is  merely  a 
means  of  fixing  the  actual  price  of  the  thing  which  is 
purchased  or  sold.  Once  the  actual  price  is  fixed,  the 
entries  in  the  books  and  accounts  should  show  only  that 
price.  A  trade  discount  is  merely  a  matter  of  bargain- 
ing between  buyer  and  seller  which  precedes  the  actual 
fixing  of  the  selling  price.    Care  should  be  taken,  how- 


TRADE  DISCOUNT  AND  CASH  DISCOUNT       275 

ever,  to  make  sure  that  the  discounts  are  really  trade 
discounts  and  not  cash  discounts,  because  the  latter  must 
be  accounted  for  in  the  books  of  account. 

8.    Cash  Discounts 

A  cash  discount  is  an  allowance  for  the  payment  of 
an  item  before  it  is  finally  due.  If,  for  instance,  goods 
are  sold  on  the  terms  of  "2/10  n/30,"  this  implies  that 
they  must  be  paid  for  at  their  billed  price  (net)  in  thirty 
days,  but  if  they  are  paid  for  in  10  days  2%  may  be  de- 
ducted from  such  price.  The  nature  of  cash  discounts 
needs  now  to  be  considered  in  order  to  determine 
whether  they  should  be  regarded  as  income  or  expense 
or  as  adjustments  of  invoice  prices. 

Opinions  vary  as  to  whether  cash  discounts  when 
taken  should  be  regarded  as  a  reduction  of  the  price  or 
as  losses  to  the  seller  and  gains  to  the  buyer  who  is  finan- 
cially able  to  secure  them  by  prompt  payment.  The 
ostensible  reason  for  allowing  cash  discounts  is  to  induce 
prompt  payment  and  thereby  to  secure  working  capital. 
While  it  is  true  that  sellers  are  sometimes  obliged  to  give 
them  rather  because  of  trade  custom  than  because  they 
need  working  capital,  nevertheless  the  fundamental  rea- 
son for  allowing  such  discounts  seems  to  be  the  desire  to 
secure  capital.  Further,  a  cash  discount  is  not  secured 
if  the  payment  is  not  made  within  the  time  limit,  and  it 
seems  illogical  to  hold  that  the  price  of  an  article  de- 
pends upon  the  time  in  which  it  is  paid  for.  Conse- 
quently, it  is  more  reasonable  to  consider  cash  discounts 
as  expenses  or  income  belonging  to  the  financial  end  of 
the  business  than  as  adjustments  of  prices.  Cash  dis- 
counts invariably  exceed  ordinary  interest  and  there- 


276         MISCELLANEOUS  ACCOUNTING  TOPICS 

fore  it  is  usually  advisable  to  borrow  money,  if  neces- 
sary, in  order  to  take  advantage  of  them. 

9.    Basis  for  Calculating  Cash  Discount 

A  cash  discount  should  be  deducted  from  the  amount 
of  the  invoice  paid  and,  since  it  is  a  premium  for  prompt 
payment,  it  should  be  calculated  only  on  the  amount 
paid.  Assume  a  purchase  of  $180  subject  to  a  2/10  dis- 
count, and  a  return  within  8  days  of  goods  invoiced  at 
$50,  thus  leaving  $130  due.  In  settling  the  account  the 
discount  of  2%  should  be  calculated  on  $130  and  not 
on  $180. 

This  procedure  seems  elementary  and  obvious,  yet 
arguments  have  been  advanced  in  favor  of  deducting 
discount  on  $180  and  such  is  the  practice  in  many  cases. 
In  justification,  it  is  maintained  that  if  the  return  be 
made  after  the  settlement  less  discount,  credit  should  be 
given  for  the  gross  amount  of  goods  returned  and  not 
for  the  $50  less  2%.  In  the  example  given,  if  the  entire 
bill  of  $180  were  paid  subject  to  discount,  the  payment 
would  amount  to  $176.40.  If  merchandise  invoiced  at 
$50  be  then  returned,  the  buyer  should  not  claim  credit 
for  $50  because  of  the  fact  that  he  has  in  effect  paid 
only  $49. 

The  force  of  this  argument  is  weakened  by  the  prob- 
ability that  most  merchants  would  allow  a  credit  of  only 
$49  under  these  circumstances.  But  even  a  credit  allow- 
ance for  the  gross  amount  would  not  be  an  argument  in 
favor  of  calculating  the  discount  on  $180  in  the  first 
assumed  case.  A  buyer  is  entitled  to  discount  only  on 
the  money  paid  because  the  discount  is  given  as  consid- 
eration for  prompt  payment. 


TRADE  DISCOUNT  AND  CASH  DISCOUNT       277 

The  suggestion  presents  itself  that  unscrupulous 
buyers  might  secure  discounts  on  the  total  invoice  in- 
stead of  on  the  net  by  withholding  returns  until  after 
payment.  Such  practice  is  not  likely  to  become  com- 
mon because  most  buyers  would  not  care  to  make  the 
necessary  outlay  and  then  wait  for  the  credit  until  the 
seller  saw  fit  to  give  it. 

10.  Bonus  on  Total  Purchases 

Sometimes  a  bonus  is  allowed  on  the  total  amount 
of  purchases  made  during  a  given  period  of  time.  Such 
a  bonus  should  be  calculated  on  the  gross  amount  and 
not  on  the  net  after  reduction  by  cash  discount.  A 
bonus  is  an  adjustment  of  the  purchase  price  and  not  a 
reward  for  prompt  payment. 

11.  Bookkeeping  for  Cash  Discounts 

There  are  three  standard  methods  of  recording  cash 
discounts.  The  first  is  to  pass  them  through  the  gen- 
eral journal;  the  second  is  to  show  them  in  the  cash  book 
as  a  rebate,  i.e.,  on  the  opposite  side  to  the  receipts  or 
payments  to  which  they  relate;  and  the  third  method  is 
to  use  discount  columns  in  the  casli  book.  These 
methods  will  now  be  illustrated. 

12.  Journalizing  Cash  Discount 

If  a  sale  of  $100  on  a  2%  cash  discount  basis  were 
made,  the  original  entry  should  be  a  debit  to  the  cus- 
tomer and  a  credit  to  Sales.  When  later  the  customer 
pays  $98,  it  is  evident  that  he  must  be  credited  with 
$100,  of  which  $98  is  cash  and  $2  is  discount.  The  credit 
of  $98  is  made  through  the  cash  book  in  the  usual  way, 


278         MISCELLANEOUS  ACCOUNTING  TOPICS 

while  the  discount  of  $2  is  passed  through  the  journal 
by  means  of  the  following  entry : 

Discount  on  Sales $2.00 

To  Customer $2.00 

On  the  buyer's  books,  conversely,  at  the  time  of  pur- 
chase the  Purchases  account  should  be  debited  and  the 
seller  credited.  When  payment  is  made  the  seller's  ac- 
count must  be  debited  with  $100,  $2  of  which  is  discount. 
The  debit  of  $98  should  be  made  from  the  cash  book  and 
that  of  $2  through  the  journal,  by  the  following  entry: 

Seller's   Account $2.00 

To  Discount  on  Purchases $2.00 

There  are  several  disadvantages  in  this  method  of 
handling  discounts.  It  is  evident  that  when  purchases 
and  sales  are  numerous,  a  considerable  number  of  en- 
tries have  to  be  made.  Moreover,  the  risk  of  error  in 
calculating  and  posting  is  greatly  increased  because  of 
the  fact  that  cash  is  entered  in  the  cash  book  and  dis- 
count in  the  journal  so  that  comparison  of  the  two 
amounts  is  inconvenient  at  the  time  of  the  entries.  The 
drawback  of  journalizing  discount  in  the  way  just  de- 
scribed led  to  the  adoption  of  the  following  method. 

13.    Cash   Discounts  Recorded  as  Cash 

In  the  example  given,  entries  in  the  seller's  cash 
book  might  be  made  as  follows:  Although  only  $98  is 
received,  $100  might  be  entered  on  the  debit  side  of  the 
cash  book  and  at  the  same  time  $2  on  the  credit  side  as  a 
payment.  The  credit  of  $100  would  then  be  made  to  the 
customer's  account  and  the  debit  of  $2  to  Discount  on 
Sales.    The  buyer  could  treat  the  discount  similarly  by 


TRADE  DISCOUNT  AND  CASH  DISCOUNT       279 

showing  on  his  cash  book  a  payment  of  $100  chargeable 
to  the  seller,  and  a  receipt  of  $2  to  be  credited  to  Dis- 
count on  Purchases,  although  as  a  matter  of  fact  there 
has  been  merely  the  one  payment  of  $98  made  by  the 
buyer. 

This  method,  though  more  convenient  than  journal- 
izing, is  subject  to  the  objection  that  the  cash  book 
debits  will  exceed  the  actual  cash  receipts  and  the  credits 
the  actual  cash  payments.  If  receipts  and  payments 
shown  in  the  cash  book  do  not  correspond  with  the  ac- 
tual amounts  paid  into  and  withdrawn  from  the  bank, 
the  verification  of  the  cash  book  figures  by  comparing 
them  with  those  of  the  bank  statements  cannot  be 
readily  made.  The  importance  and  method  of  making 
this  comparison  are  discussed  in  Volume  IV  of  this 
series.  Here  it  is  merely  necessary  to  state  that  because 
of  this  difficulty  modern  practice  usually  follows  a  third 
and  improved  method  of  recording  cash  discounts,  de- 
scribed below. 

14.    Cash  Book  Column  for  Discount 

The  most  convenient  way  of  recording  cash  dis- 
counts is  to  provide  a  column  on  each  side  of  the  cash 
book  which  in  effect  contains  journal  entries  for  the  dis- 
count. The  first  column  on  the  debit  side  may  be  used 
for  net  cash  received,  the  second  for  discount  on  sales, 
and  the  third  for  accounts  receivable.  In  the  example 
given  $98  would  be  entered  in  the  net  cash  column,  $2 
in  the  discount  on  sales  column,  and  $100  in  the  accounts 
receivable  column.  The  credit  side  of  the  cash  book 
should  be  ruled  in  the  same  way,  the  first  column  being 
for  the  net  payment,  the  second  for  discount  on  pur- 


280         MISCELLANEOUS  ACCOUNTING  TOPICS 

chases,  and  the  third  for  accounts  payable.  The  buyer 
in  the  example  given  would  enter  $98  in  the  net  pay- 
ment column,  $2  in  the  discount  on  purchases  column, 
and  $100  in  the  accounts  payable  column. 

This  method  has  two  advantages.  In  the  first  place 
it  brings  the  discount  and  the  net  cash  together  on  one 
line  in  one  book  so  that  the  amount  can  be  verified  by 
mere  inspection.  There  is  thus  practically  no  danger 
that  the  discount  will  be  incorrectly  calculated  or  posted 
to  a  wrong  account.  A  further  advantage  is  that  the 
discount  columns  can  be  added  and  the  total  of  each 
posted  as  one  amount  at  the  end  of  a  month,  thus  elimi- 
nating the  postings  in  detail  which  are  required  under 
either  of  the  two  preceding  methods. 

The  posting  of  the  totals  of  the  discount  columns  in 
the  cash  book  is  usually  made  directly  from  the  cash 
book,  the  folio  being  entered  under  the  total  which  is 
posted.  Some  bookkeepers  prefer  to  carry  the  total  dis- 
count on  sales  over  to  the  right-hand  page  and,  con- 
versely, the  total  discount  on  purchases  over  to  the  left- 
hand  page — to  be  posted  from  those  sides  rather  than 
from  the  original  columns.  The  reason  for  this  is  to 
secure  consistency  by  posting  all  items  from  the  debit 
side  of  the  cash  book  (with  the  exception  of  net  cash)  to 
the  credit  of  accounts,  and  all  items  from  the  credit  side 
(except  cash)  to  the  debit  of  accounts.  Such  cross  en- 
tries, however,  are  rarely  advisable. 

15.    Showing  of   Discount  on   Financial  Statements 

Financial  statements  should  show  the  discounts  on 
purchases  and  sales.  If  the  discounts  are  regarded  as 
price  reductions,  then  it  would  be  desirable  to  show  the 


TRADE  DISCOUNT  AND  CASH  DISCOUNT        281 

gross  amounts  of  purchases  and  sales  and  also  the 
amounts  of  the  discounts,  deducting  the  latter  from  their 
respective  gross  amounts  and  extending  the  net  in  each 
case.  If  the  more  commonly  accepted  view  is  held  that 
cash  discounts  do  not  affect  the  prices  at  which  things 
are  sold,  it  is  advisable  to  show  cash  discounts  as  an  ex- 
pense of  financing  the  business  or  as  an  income  result- 
ing from  the  profitable  use  of  ready  cash.  This  point 
will  be  more  fully  discussed  in  Volume  IV. 

16.    Provision  for  Discounts  in  the  Closing  Entry 

In  preparing  the  adjusting  entries  at  the  end  of  a 
fiscal  period,  it  is  necessary  to  provide  for  all  elements 
affecting  profit  and  loss  which  are  not  already  recorded 
in  the  accounts.  A  question  frequently  raised  is  whether 
provision  should  be  made  for  cash  discounts  which  cus- 
tomers are  expected  to  take  and  which  the  business  ex- 
pects to  receive  on  its  own  accounts  payable.  Where 
the  practice  in  a  particular  trade  is  almost  invariably  to 
take  discounts,  the  argument  seems  sound  that  in  a  bal- 
ance sheet  accounts  receivable  and  payable  should  be 
reduced  by  the  cash  discounts  which  are  expected  to  be 
taken  on  both  sides.  But  when  such  reductions  are  made 
it  does  not  necessarily  follow  that  the  offsetting  adjust- 
ment should  be  to  expense  and  income  accounts  for  the 
period  ending  with  the  balance  sheet  date.  If  the  reduc- 
tion of  accounts  receivable  is  debited  to  Discount  on 
Sales,  and  the  reduction  of  accounts  payable  is  credited 
to  Discount  on  Purchases,  although  neither  of  these  dis- 
counts has  yet  been  taken,  the  effect  would  be  to  show 
the  discounts  which  are  expected  to  be  taken  in  a  suc- 
ceeding period  as  expense  and  income  of  the  current 


282         MISCELLANEOUS  ACCOUNTING  TOPICS 

period.  Since  the  discount  does  not  become  effective 
until  it  is  taken,  and  the  right  to  take  it  is  lost  if  pay- 
ment is  not  made  within  a  specified  time,  it  seems  more 
logical  to  treat  cash  discounts  as  income  or  expense  of 
the  financial  period  in  which  they  are  actually  taken. 
Consequently,  if  accounts  receivable  and  payable  are 
reduced  by  anticipated  discounts,  the  offsetting  entries 
should  not  be  to  current  cash  discount  accounts  but  to 
suspense  accounts  raised  temporarily  and  closed  at  the 
beginning  of  the  next  fiscal  period. 

17.    Desirability  of  Abolishing  Cash  Discounts 

From  time  to  time,  associations  of  credit  men  have 
considered  the  desirability  of  abolishing  cash  discounts. 
Despite  all  attempts  to  stop  unwarranted  deductions, 
many  business  houses  still  deduct  discounts  to  which 
they  are  not  entitled.  This  is  done  on  the  assumption 
that  the  seller  will  not  run  the  risk  of  losing  a  customer 
by  insisting  on  the  exact  discount  terms  quoted.  This 
questionable  practice  is  due  to  the  fact  that  the  right  to 
deduct  the  discount  is  given  to  the  buyer,  leaving  him 
free  if  he  does  not  consider  the  moral  aspect  of  the 
transaction,  to  take  advantage  of  a  discount  to  which 
he  is  not  entitled. 

Many  credit  men  believe  that  this  right  should  be 
taken  from  the  buyer  and  given  to  the  seller.  Instead 
of  allowing  the  discount  to  be  deducted  by  the  buyer, 
the  seller  should  be  required  to  return  a  bonus  equal  in 
amount  to  the  cash  discount,  if  the  buyer  pays  within 
the  discount  period.  There  is  a  general  feeling  that 
sellers  could  be  trusted  to  do  this  in  view  of  the  pres- 
sure which  could  be  brought  to  bear  upon  them  by 


TRADE  DISCOUNT  AND  CASH  DISCOUNT        283 

threatened  litigation.  A  seller  who  failed  to  comply 
regularly  with  such  a  practice  would  soon  lose  his  cus- 
tomers; and,  as  sellers  are  as  a  rule  commercially  more 
stable  than  buyers,  little  risk  seems  to  be  attached  to 
the  working  of  the  system.  The  additional  cost  to  the 
seller  in  clerical  labor  would  probably  be  more  than  off- 
set by  the  saving  in  unwarranted  discounts. 

There  is  little  justification  today  for  any  kind  of  dis- 
count scheme.  These  rebates  are  a  greater  source  of 
trouble  than  any  benefit  which  may  be  derived  from 
their  use.  Any  advantage  that  formerly  accrued  to  the 
seller  by  thus  inducing  prompt  payment  is  in  many  in- 
stances now  lost  by  the  custom  of  post-dating  invoices. 
The  modern  tendency  is  toward  simplification.  It 
should  seriously  be  considered  whether  a  system  which 
causes  so  much  clerical  labor  and  creates  so  much  fric- 
tion as  does  that  of  cash  discounts  should  not  be 
abolished. 


REVIEW  QUESTIONS 

Is  cash  discount  on  purchases  when  taken  an  income  or  a  deduc- 
tion from  the  cost  of  the  goods  ? 

Is  cash  discount  on  sales  when  taken  a  loss  or  a  deduction  from 
the  selling  price  of  the  goods  ? 

Describe  the  system  of  running  a  discount  column  in  the  cash 
book,  and  show  how  the  entries  are  made  both  in  the  general 
ledger  and  in  the  subsidiary  ledger. 

Do  you  approve  of  the  system  of  cash  discounts  ? 


CHAPTER    XXVI 
ILLUSTRATIVE    CASH    BOOK   ENTRIES 

1.     Ruling  of  Cash  Book 

A  columnar  cash  book  in  which  a  number  of  hypo- 
thetical transactions  are  entered  ready  for  posting  is 
presented  in  this  chapter  for  the  purpose  of  illustrating 
certain  points  in  the  use  of  controlling  accounts.  It 
should  be  understood  that  there  is  little  uniformity  in  the 
columnar  ruling  of  cash  books  and  that  the  needs  of  a 
particular  business  determine  the  arrangement  of  the 
headings  in  each  case.  The  illustration  shown  is  not  in- 
tended to  present  a  standard  form.  It  is  given  merely 
for  the  purpose  of  explaining  the  procedure  of  cash  an- 
alysis when  the  details  of  customers'  accounts  are  posted 
to  the  sales  ledger  and  of  creditors'  accounts  to  a  pur- 
chase ledger,  with  controlling  accounts  for  each  kept  in 
the  general  ledger. 

In  the  form  of  cash  book  shown  in  Form  11  (pages 
288  and  289),  it  will  be  noted  that  the  first  amount  col- 
umn on  each  side  is  entitled  "Net  Cash."  The  net  cash 
column  on  the  debit  side  is  used  to  record  the  cash  actu- 
ally received,  and  the  corresponding  column  on  the  credit 
side  contains  the  amounts  of  checks  drawn.  It  is  evident, 
therefore,  that  the  excess  of  the  total  of  this  column  on 
the  debit  side  over  the  total  of  the  corresponding:  column 
on  the  credit  side  represents  the  balance  of  cash  in  bank. 

Adjoining  the  net  cash  column  on  the  debit  side  is 
one  for  discounts  allowed  to  customers  and  on  the  credit 

284 


ILLUSTRATIVE  CASH  BOOK  ENTRIES  285 

side  one  for  discounts  received  from  creditors.  Follow- 
ing the  discount  column  on  the  debit  side  is  a  column  in 
which  are  entered  the  gross  amounts  to  be  credited  to 
customers'  accounts  in  the  sales  ledger,  the  total  of  which 
at  the  end  of  each  month  is  to  be  credited  to  the  Sales 
Ledger  controlling  account.  On  the  credit  side  a  similar 
column  entitled  "Purchase  Ledger"  is  used  for  the 
recording  of  the  gross  amounts  to  be  debited  to  creditors' 
accounts,  with  a  corresponding  total  debit  posting  to  the 
Purchase  Ledger  controlling  account. 

On  the  debit  side  of  the  cash  book  a  column  is  pro- 
vided for  the  recording  of  cash  sales  and  the  accumula- 
tion of  a  monthly  total  for  posting  to  the  credit  of  a  Cash 
Sales  account.  On  the  credit  side  of  the  cash  book  a  col- 
umn is  provided  for  the  similar  collection  of  payments 
chargeable  to  general  expense,  the  total  of  which  at  the 
end  of  each  month  is  to  be  posted  to  the  General  Expense 
account  in  the  general  ledger.  The  last  column  on  each 
side  of  the  cash  book  is  entitled  "Sundries"  and  is  used 
for  the  entry  of  items  to  which  the  other  columns  would 
not  be  applicable. 

2.    Illustrative  Transactions 

September,  1919 

1.  Cash  balance  $3,248.11.  Purchases  8  tons  coal  at 
$6.25;  $10  worth  of  postage  stamps;  and  %  do*, 
brooms  for  store  and  office  use  at  $4.20.  Issued 
checks  in  payment. 

8.  Redeemed  note  payable  of  $500  at  bank  with  3  months* 
accrued  interest,  by  check. 

4.  Received  check  from  J.  Stratton  &  Co.  on  invoice  due 
today  of  $439.20  less  8%.  Weekly  cash  sales  per 
abstract  $736.91.    Petty  cash  expense  items  $6.84. 


286         MISCELLANEOUS  ACCOUNTING  TOPICS 

7.  We  received  notice  that  one  of  our  old  customers,  Max- 
well Bros.,  became  bankrupt.  We  have  just  suc- 
ceeded in  securing  a  certified  check  from  them  of 
$243.84,  which  is  accepted  in  full  of  their  account, 
at  the  rate  of  68  cents  on  the  dollar. 

10.  Paid  invoices  due  today  to  the  following  creditors: 

Bliss  Mfg.    Co.    $291.25    less    6-2%;    K.    Emerson 
Co.  $428.40  less  3%,  and  J.  Curtis  $97.18  net. 

11.  Weekly  cash  sales  $819.56.    Petty  cash  expense  $5.93. 
15.    We  negotiated   Browning  &   Co.'s   note   of  $800   at 

bank.  The  note  was  dated  August  1 1  at  3  months, 
with  interest  at  5%.  The  bank  charged  6%  dis- 
count. 

18.  Weekly  cash  sales  $714.37.  Petty  cash  expenses 
$5.32. 

21.  We  sold  through  our  broker  18  shares  of  N.  Y.  C. 
stock  at  1041/2,  brokerage  %%.  We  receive  the 
proceeds  by  check. 

24.  We  received  $350.50  from  Snyder  &  Co.,  in  settlement 

of  account  to  date,  less  2%  on  an  invoice  of  $237.95, 
and  an  old  balance  of  $117.31  net. 

25.  Weekly    cash    sales    $830.49.      Petty    cash    expenses 

$7.05. 
27.    At  a  local  Industrial  Exhibit  we  were  awarded  a  cash 
prize  of  $25. 

29.  Booth  Mfg.  Co.  remit  their  check  in  full  of  their  in- 

voice of  $196.08  less  6-2%.  Our  bank  charges  20 
cents  exchange  on  the  check. 

30.  We  purchased  a  draft  on  New  York  by  check  at  !/4% 

exchange,  and  remitted  it  to  Jay  &  Co.  in  full  of 
invoice  of  $829.67  less  terms  3%.  Paid  salaries  to 
date  $180. 

3.     Cash  Book  Entries 

Form  11  shows  the  entry  of  each  transaction  pre- 
sented in  §  2.  In  succeeding  paragraphs  comment  is 
made  on  such  of  these  entries  as  may  not  be  clear. 


ILLUSTRATIVE  CASH  BOOK  ENTRIES  287 

4.     Comment  on  Transactions 

The  following  comments  are  designated  with  the 
date  of  the  transaction  given  in  §  2. 

September  1.  The  balance  at  September  1,  1919, 
is  entered  on  the  receipt  side  of  the  cash  book  in  the  net 
cash  column  and  repeated  in  the  sundries  column.  This 
is  not  to  be  credited  to  any  account,  but  it  will  corre- 
spond with  the  balance  in  the  Cash  account  in  the  ledger 
at  September  1, 1919.  The  amount  is  entered  in  the  net 
cash  column  in  order  that  the  excess  of  that  column  over 
the  total  of  the  corresponding  column  on  the  credit  side 
will  represent  the  balance  of  cash  in  bank.  The  amount 
is  repeated  in  the  sundries  column  in  order  that  the 
monthly  totals  of  all  columns  may  "cross-foot"  as  ex- 
plained in  a  succeeding  section. 

The  payments  for  expenses  are  entered  on  the  credit 
side  of  the  cash  book,  the  details  being  indicated  in  the 
explanation  space.  The  total  amount  of  $61.05,  which 
is  assumed  to  have  been  covered  by  one  check,  is  entered 
in  the  net  cash  column  and  repeated  in  the  general  ex- 
pense column  because  the  payments  are  chargeable  to 
that  account.  In  a  larger  business  a  General  Expense 
account  would  not  be  adequate  to  record  all  the  ex- 
penses, but  an  individual  account  with  each  kind  of  ex- 
pense would  be  required.  As  explained  in  Volume  II, 
the  analysis  of  the  expenditures  for  expense  is  generally 
made  in  a  purchase  journal  or  voucher  register  instead 
of  in  the  cash  book,  but  the  present  form  is  given  to  illus- 
trate a  procedure  adequate  for  a  small  business. 

3.  It  will  be  noted  that  the  payment  of  this  note, 
although  made  by  one  check,  requires  two  lines  for  entry 
in  the  cash  book.  This  results  from  the  fact  that  the  face 


288 


MISCELLANEOUS  ACCOUNTING  TOPICS 


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290         MISCELLANEOUS  ACCOUNTING  TOPICS 

of  the  note,  namely  $500,  is  chargeable  to  Notes  Pay- 
able account  and  the  interest  of  $7.50  is  chargeable  to 
Interest  account. 

4.  The  recording  of  the  receipt  from  J.  Stratton  & 
Co.  is  typical  of  receipts  from  customers  to  whom  cash 
discounts  are  allowed.  It  will  be  noted  that  the  amount 
of  cash  received  is  entered  in  the  net  cash  column,  the 
discount  in  the  discount  on  sales  column,  and  the  gross 
amount  to  be  credited  to  the  customer's  account  is  en- 
tered in  the  sales  ledger  column. 

7.  The  cash  book  entry  for  the  receipt  from  Max- 
well Bros,  will  result  in  a  credit  to  their  account  of  the 
cash  received,  but  a  further  credit  should  be  made  in  the 
journal  to  record  the  fact  that  their  account  is  closed. 
The  account  to  be  debited  in  this  journal  entry  will  be 
the  Reserve  for  Bad  Debts  account  in  view  of  the  fact 
that  the  customer  has  become  bankrupt. 

10.  The  entries  for  payment  to  creditors  from 
whom  cash  discounts  are  received  are  similar  to  the  en- 
tries for  receipts  from  customers  who  have  taken  cash 
discounts,  and  therefore  require  no  comment. 

15.  It  will  be  noted  that  Browning  &  Co.'s  note 
for  $800  bore  interest  at  5  per  cent.  The  amount  re- 
ceivable on  the  note  at  its  maturity  thus  would  be  $810. 
The  note,  however,  was  discounted  September  15,  and 
the  bank  charged  $7.70  for  discount.  The  entry  of  this 
transaction  requires  a  credit  of  $810  to  Notes  Receiv- 
able Discounted  account  and  a  debit  to  Discount  ac- 
count of  $7.70,  the  amount  of  the  cash  proceeds,  $802.30, 
being  entered  in  the  net  cash  column.  The  credit  to 
Notes  Receivable  Discounted  account  is  made  for  rea- 
sons explained  in  Chapter  XXVII.    The  debit  of  $7.70 


ILLUSTRATIVE  CASH  BOOK  ENTRIES  291 

in  the  Discount  account  is  in  reality  a  journal  entry  but 
is  made  in  the  cash  book  for  bookkeeping  convenience 
in  order  that  the  entire  transaction  may  be  recorded  in 
one  place.  As  this  latter  entry  is  a  debit,  the  amount  is 
entered  in  the  sundries  column  in  red  ink  to  distinguish 
it  from  the  other  entries  which  are  to  be  credited  to  their 
respective  accounts. 

27.  The  credit  for  the  cash  prize  of  $25  is  made  to 
the  Prizes  account.  Bookkeepers  are  inclined  to  make 
credits  such  as  this  to  the  Profit  and  Loss  account,  but 
such  practice  is  not  considered  sound  because  the  Profit 
and  Loss  account  should  be  used  only  as  a  clearing 
house  account  in  which  to  collect  the  balances  of  all  the 
nominal  accounts  at  the  end  of  each  fiscal  period. 

It  is  believed  that  the  other  transactions  do  not  re- 
quire comment. 

5.     Postings  from  Cash  Book 

The  only  items  on  the  debit  side  of  the  cash  book  to 
be  posted  individually  are  those  in  the  sales  ledger  col- 
umn and  in  the  sundries  column.  Amounts  in  the  former 
column  are  to  be  credited  to  customers'  accounts  in  the 
sales  ledger,  and  amounts  in  the  latter  column  (with 
the  exception  of  the  balance  at  September  1,  1919)  are 
posted  to  the  credit  of  the  accounts  specified  in  the  gen- 
eral ledger,  care  being  taken,  however,  to  post  the  dis- 
count item  of  $7.70  entered  in  red  to  the  debit  of  that 
account. 

Similarly,  the  only  items  on  the  credit  side  of  the 
cash  book  to  be  posted  individually  are  those  in  the  pur- 
chase ledger  column  and  in  the  sundries  column.  The 
amounts  in  the  purchase  ledger  column  are  to  be  debited 


292         MISCELLANEOUS  ACCOUNTING  TOPICS 

to  accounts  with  creditors  in  the  purchase  ledger,  and 
items  in  the  sundries  column  are  to  be  posted  to  the 
debit  of  the  designated  accounts  in  the  general  ledger. 

In  the  net  cash  column  on  the  debit  side  the  balance 
at  September  1,  1919,  is  deducted  from  the  total  to  give 
the  amount  of  receipts  during  the  month,  $7,019.90, 
and  this  amount  is  debited  to  the  Cash  account  in  the 
general  ledger.  The  total  of  the  discount  on  sales  col- 
umn is  posted  to  the  debit  of  that  account  in  the  general 
ledger.  The  totals  of  the  sales  ledger  column  and  the 
cash  sales  column  are  posted  to  the  credit  of  their  re- 
spective accounts  in  the  general  ledger.  The  total  of  the 
sundries  column  is  not  posted  because  the  individual 
items  making  up  that  total  have  been  posted  in  detail. 
It  will  be  noted  that  the  total  of  the  net  cash  column, 
$10,268.01,  plus  the  discount  on  sales  total,  $21.86,  both 
of  which  are  debit  items,  equals  the  total  of  the  three  re- 
maining columns  which  are  credit  items.  Thus  it  will 
be  seen  that  the  debits  from  this  side  of  the  cash  book 
equal  the  credits. 

On  the  credit  side  of  the  cash  book  the  total  of  the 
net  cash  column,  $2,378.33,  represents  the  total  pay- 
ments for  the  month  and  is  credited  to  the  Cash  account 
in  the  general  ledger;  the  total  of  the  discount  on  pur- 
chases column,  $43.57,  is  credited  to  that  account  in 
the  general  ledger.  The  totals  of  the  purchase  ledger 
column  and  the  general  expense  column  are  debited  to 
their  respective  accounts  in  the  general  ledger,  and  the 
total  of  the  sundries  column  is  not  posted  because  the 
items  composing  it  have  been  posted  in  detail.  By  add- 
ing the  balance  at  September  30,  1919  to  the  total  pay- 
ments for  September,  a  total  of  $10,268.01  is  obtained 


ILLUSTRATIVE  CASH  BOOK  ENTRIES  293 

which  corresponds  with  the  total  of  the  net  cash  column 
on  the  debit  side  and  for  that  reason  each  of  these 
amounts  is  designated  as  "total  per  contra,"  per  contra 
implying  a  reference  to  the  contra  or  opposite  page. 


CHAPTER    XXVII 
NOTES    AND    TRADE    ACCEPTANCES 

1.  Definition  of   Promissory    Note 

A  promissory  note  is  a  written  unconditional  prom- 
ise, signed  by  the  maker,  to  pay  to  the  bearer  or  to  the 
order  of  a  named  payee  a  certain  sum  in  money  on 
demand  or  at  a  fixed  or  determinable  future  time.  If 
such  a  note  meets  all  the  requirements  contained  in  the 
above  definition,  it  is  said  to  be  negotiable.  Under  the 
law  it  may  be  passed  freely  from  one  person  to  another 
by  indorsement — meaning  that  the  payee  or  present 
owner  signs  his  name  on  the  back  of  the  note.  Unless 
such  a  signature  is  expressly  stated  to  be  "without  re- 
course," the  indorsee,  that  is,  the  person  to  whom  the 
note  is  transferred,  can  hold  his  immediate  indorser  and 
all  previous  indorsers  liable  for  its  payment  in  case  the 
maker  of  the  note  fails  to  pay  it  at  maturity.  Thus  a 
contingent  liability  is  imposed  upon  the  indorser  of  a 
note,  of  which  the  accountant  should  take  full  note,  as 
will  be  now  explained. 

2.  Notes   Receivable   and   Notes  Payable 

Notes  are  either  receivable  or  payable,  depending 
upon  the  point  of  view  from  which  they  are  considered. 
The  same  note  will,  of  course,  be  a  note  payable  from 
the  viewpoint  of  the  maker,  and  a  note  receivable  from 
that  of  the  payee  or  present  holder.  Notes  receivable 
are  assets,  and  notes  payable  are  liabilities,  and  the 

294 


NOTES  AND  TRADE  ACCEPTANCES     295 

titles  of  their  respective  accounts  should  be  "Notes  Re- 
ceivable" and  "Notes  Payable."  The  fact  that  they  are 
sometimes  called  "bills  receivable"  and  "bills  payable" 
leads  to  a  discussion  of  how  such  a  practice  arose  from 
the  use  of  bills  of  exchange. 

3.    Bills  of  Exchange 

A  bill  of  exchange,  commonly  called  a  draft,  is  an 
unconditional  written  order  to  pay  a  certain  sum  in 
money  on  demand  or  at  a  fixed  or  determinable  future 
time  to  order  or  to  bearer  and  addressed  to  a  definite 
person  known  as  the  drawee.  Such  an  order  obviously 
is  of  no  value  until  it  is  accepted  as  vahV  by  the  drawee. 
Evidence  of  acceptance  is  the  word  "Accepted"  written 
by  the  drawee  over  his  signature  on  the  face  of  the  bill. 
When  that  is  done  the  drawee  becomes  the  acceptor  of 
the  bill  and  is  the  person  primarily  liable  thereon.  If 
he  fails  to  pay  as  he  has  agreed  to  do,  the  drawer,  who 
signs  the  bill  before  its  presentation  to  the  drawee,  can 
be  held,  the  latter  thus  assuming  a  contingent  liability 
similar  to  that  of  an  indorser. 

An  accepted  bill  constitutes  a  bill  receivable  in  the 
hands  of  the  holder,  and  a  bill  payable  from  the  ac- 
ceptor's viewpoint.  History  shows  that  bills  were  in 
use  before  notes;  consequently,  accounts  which  were 
first  properly  called  "bills  receivable"  and  "bills  pay- 
able" were  often  continued  under  those  same  captions 
when,  later,  notes  almost  entirely  displaced  bills  of  ex- 
change. Hence,  to  this  day  these  titles  are  used.  Mod- 
ern practice,  however,  tends  towards  simplicity  and 
directness  and  so  the  word  "notes"  is  now  generally 
substituted  for  "bills"  in  the  title  of  such  accounts. 


296        MISCELLANEOUS  ACCOUNTING  TOPICS 

4.  Dishonored  Notes 

One  of  the  requirements  of  a  note  given  in  the  fore- 
going definition  is  that  it  be  payable  on  demand  or  at 
a  fixed  or  determinable  future  time.  Since  a  note  which 
is  not  paid  at  its  maturity  ceases  to  be  payable  on  de- 
mand or  at  a  fixed  or  determinable  future  time,  it  ceases 
to  be  a  note  in  the  eyes  of  the  law,  and  therefore  it 
should  cease  to  be  considered  a  note  in  the  accounts. 
Dishonored  notes  should  never  be  represented  in  a  notes 
account  on  the  ledger  or  on  any  statement.  The  book- 
keeping for  such  notes  is  discussed  in  §  7. 

5.  Bookkeeping  Upon  Receipt  of   Note 

The  bookkeeping  for  notes  receivable  falls  into  three 
groups,  covering  respectively  the  receipt  of  the  note, 
its  payment,  and  its  dishonor.  When  a  note  is  received, 
a  Notes  Receivable  account  should  be  opened  and  deb- 
ited with  the  face  value  of  the  note.  Such  a  note  is  an 
asset  and  the  account  which  represents  it  should  be 
debited  to  record  the  acquisition  of  the  asset.  If  the 
note  is  received  from  a  debtor,  his  account  should  be 
credited.  If  it  is  received  for  money  lent,  the  credit 
would  be  to  Cash.  A  typical  entry  for  the  receipt  of 
a  note  from  a  customer  would  be: 

Notes    Receivable $ 

To  Accounts  Receivable $ 


The  effect  of  this  entry  is  to  cancel  as  much  of  a 
customer's  open  account  receivable  as  is  covered  by  the 
note  but  the  customer  in  question  still  remains  liable  for 
the  amount  of  his  indebtedness.  The  change  is  merely 
in  the  form  of  his  indebtedness,  a  liability  on  the  note 


NOTES  AND  TRADE  ACCEPTANCES      297 

being  substituted  for  that  on  the  open  account.  For 
that  reason  it  is  sometimes  desirable  to  indicate  in  his 
account  that  his  indebtedness  still  remains,  whereas 
under  the  above  entry  it  would  appear  to  be  canceled. 
This  can  be  done  by  inserting  a  brief  memorandum  inj 
the  explanation  column  of  his  account  stating  that  a 
note  has  been  received,  this  memorandum  being  can- 
celed when  the  note  is  paid.  If  most  customers  settle  by 
notes,  which  is  rarely  the  case,  and  this  information  is 
needed,  a  ledger  account  can  be  provided  with  two 
amount  columns  on  each  side,  in  which  on  each  side  one 
column  can  be  used  for  notes  and  one  for  open  account 
items. 

6.    Bookkeeping  Upon  Collection  of  Notes 

When  a  note  receivable  is  collected,  the  entry  is 
merely  a  debit  to  Cash  and  a  credit  to  Notes  Receivable. 
In  the  latter  account  each  note  may  be  entered  on  a 
separate  line,  with  the  credit  for  its  payment  on  the 
same  line.  In  this  way  the  notes  which  compose  the 
balance  of  the  account  will  be  apparent.  However,  it 
is  better  practice  to  use  in  connection  with  the  ledger 
account  a  notes  receivable  register  as  described  in  §  12 
and  also  in  Volume  II,  in  which  to  keep  a  separate  rec- 
ord of  each  individual  note.  If  interest  has  been  col- 
lected on  the  note,  such  interest  should  be  credited  to 
an  Interest  account,  as  the  Notes  Receivable  account 
should  show  only  face  values.  In  the  rare  case  where  the 
principal  or  face  value  of  a  note  received  from  a  cus- 
tomer includes  interest  on  his  account,  the  Notes  Re- 
ceivable account  should  be  debited  with  the  face  of  the 
note,  the  customer's  account  credited  with  the  items  in- 


298         MISCELLANEOUS  ACCOUNTING  TOPICS 

eluded  in  the  note,  and  Interest  account  credited  to  show 
the  income  from  interest. 

All  interest  on  notes,  whether  receivable  or  payable, 
should  be  adjusted  at  the  end  of  each  fiscal  period  to 
record  the  true  expense  and  income  for  the  period. 

7.    Bookkeeping  Upon  Dishonor  of  Note 

If  the  maker  of  a  note  fails  to  pay  it  at  maturity, 
Notes  Receivable  account  should  at  once  be  credited 
because  the  note  as  such  has  ceased  to  exist.  But  the 
maker  does  not  escape  liability.  Instead  of  owing 
money  on  the  note  he  now  owes  it  on  open  account,  and 
he  should  be  charged  with  the  face  of  the  note  and  also 
with  any  expense  which  may  have  been  incurred  because 
of  his  failure  to  pay,  such  as  protest  charges.  If  the  note 
was  originally  credited  to  a  customer's  account,  the 
amount  of  the  dishonored  note  together  with  the  ex- 
pense should  be  debited  to  his  account.  If  the  note  has 
been  taken  for  a  loan  made,  then  the  debit  should  be 
to  a  personal  account  with  the  borrower. 

Notes  which  are  dishonored  should  be  protested. 
Specifically,  protest  means  that  the  fact  of  presentation 
for  payment  and  the  refusal  to  pay  are  sworn  to  before 
a  notary  public  and  all  indorsers  notified.  This  for- 
mality involves  some  expense  and  this  expense  should 
be  charged  to  the  maker  of  the  note  whose  failure  to 
pay  has  caused  it.  If  the  note  has  been  given  to  the 
payee's  bank  for  collection  and  the  bank  protests  it,  the 
bank  will  charge  the  expense  of  protest  to  the  payee's 
account.  In  this  event  the  protest  expense  should 
be  entered  in  the  payee's  cash  book  and  charged  to  the 
personal  account  of  the  maker  of  the  note.     The  face 


NOTES  AND  TRADE  ACCEPTANCES      299 

of  the  note  then  should  be  debited  to  him  through  the 
journal. 

8.    Discounting  Notes  Receivable 

Since  a  note  which  complies  with  the  legal  require- 
ments specified  in  the  definition  in  §  1  can  readily  pass 
from  hand  to  hand,  the  payee  of  such  a  note  need  not 
wait  until  its  maturity  to  realize  the  amount  due  on  it 
if  he  can  find  anyone  who  is  willing  to  buy  the  note 
from  him.  He  will  have  no  difficulty  in  selling  it  if  his 
own  credit  is  good,  because  when  he  sells  it  he  will  be 
required  to  indorse  it  and  thus  will  himself  become 
liable  for  its  payment  if  the  maker  fails  to  pay.  The 
selling  of  a  note  in  this  way  is  known  as  "discounting 
the  note."  Notes  are  usually  discounted  at  a  bank  be- 
cause banks  make  a  business  of  purchasing  notes  in  this 
manner ;  but  the  sale  of  a  note  to  any  person  constitutes 
its  discounting  and  requires  the  same  accounting  treat- 
ment. 

The  purchaser  of  a  note  charges  interest  for  the 
accommodation  he  gives,  and  this  interest  charge  is 
known  as  the  discount  on  the  note.  The  holder  of  the 
note  who  discounts  it  is  willing  to  pay  this  discount  in 
order  to  secure  cash  for  the  note  before  its  maturity. 
Although  it  seems,  logically,  that  the  discount  taken 
should  be  interest  on  the  amount  advanced  by  the  pur- 
chaser of  the  note,  the  common  practice  is  different. 
The  purchaser  of  the  note  deducts  his  interest  charge 
from  the  amount  which  he  is  to  receive  at  its  maturity; 
therefore,  the  holder  of  a  note  who  discounts  it  pays 
interest  on  more  money  than  he  actually  receives.  Such 
discount  is  known  as  bank  discount.  While  it  may  exceed 


300         MISCELLANEOUS  ACCOUNTING  TOPICS 

the  legal  rate,  because  the  seller  of  the  note  does  not 
receive  all  the  money  on  which  he  pays  interest,  the 
practice  has  become  so  well  established  that  it  has  been 
legalized.    It  is  in  effect  interest  paid  in  advance. 

9.    Bookkeeping  at  Time  of  Discount 

It  is  obvious  that  cash  should  be  debited  with  the 
amount  of  the  proceeds  received  when  a  note  is  dis- 
counted, and  an  expense  account  called  "Discount" 
should  be  debited  with  the  amount  of  discount.  It  is 
not  obvious,  however,  which  account  should  be  credited. 
It  is  true  that  the  note  is  no  longer  an  asset  because 
it  has  been  sold  and  title  to  it  has  been  transferred  to 
another  owner.  It  might  be  argued  from  this  that 
Notes  Receivable  account  should  be  credited  to  record 
the  decrease  of  the  asset.  This  argument  is  good  but 
it  does  not  go  far  enough.  While  it  is  true  that  the 
asset  has  been  decreased,  an  important  fact  must  not  be 
overlooked.  That  fact  is  the  contingent  liability  as- 
sumed by  the  holder  of  the  note  when  he  indorsed  it 
at  the  time  of  discount. 

The  liability  of  the  person  who  discounts  a  note  is 
contingent  upon  the  maker's  failing  to  pay  it  at  matu- 
rity; and  unless  this  liability  is  recorded  in  some  way  it 
may  be  forgotten.  If  forgotten  the  original  holder  who 
discounted  the  note  may  be  caught  without  sufficient 
cash  to  meet  his  contingent  liability  should  this  liability 
become  actual.  The  best  way  to  record  this  contingent 
liability  is  to  credit,  at  the  time  of  discount,  a  new  ac- 
count called  "Notes  Receivable  Discounted"  instead  of 
Notes  Receivable.  Such  credit  will  not  affect  the  Cap- 
ital account  because  it  will  be  offset  by  the  Notes  Re- 


NOTES  AND  TRADE  ACCEPTANCES      301 

ceivable  account  which  will  still  contain  the  debit  for 
the  note.  The  credit  to  the  Notes  Receivable  Discounted 
account  will  be  merely  a  suspended  credit  properly 
belonging  to  the  Notes  Receivable  account  but  with- 
held for  the  time  being  as  a  warning  that  a  contingent 
liability  exists. 

On  the  balance  sheet  the  balance  of  the  Notes  Re- 
ceivable Discounted  account  may  be  deducted  from  the 
balance  of  the  Notes  Receivable  account;  it  may  be 
stated  as  a  contingent  liability  on  the  liability  side;  or 
both  it  and  the  equivalent  amount  of  notes  receivable 
may  be  ignored  as  assets  and  liabilities  within  the  state- 
ment but  be  referred  to  in  a  footnote.  Attention  should 
always  be  called  in  some  way  to  the  contingent  liability. 
Failure  to  provide  for  it  has  caused  the  ruin  of  many  a 
business. 

10.    Bookkeeping  Upon  Payment  of  Discounted  Note 

Under  the  law,  if  an  indorser  of  a  note  is  not  notified 
of  its  dishonor  within  a  reasonable  time,  he  cannot  be 
held  liable  on  his  indorsement.  Hence,  one  who  dis- 
counts a  note  will  be  released  from  his  contingent  liabil- 
ity if  he  is  not  notified  thereof.  If,  however,  there  is 
any  question  as  to  the  maker's  intention  or  ability  to 
pay,  the  person  who  discounted  the  note  should  at  its 
maturity  ascertain  by  inquiry  whether  or  not  it  has 
been  paid. 

The  bookkeeping  upon  payment  of  the  note  by  the 
maker  is  simple.  All  that  is  required  is  an  entry  can- 
celling both  the  contingent  liability  represented  by 
Notes  Receivable  Discounted  account  and  the  contin- 
gent asset  shown  by  the  Notes  Receivable  account.    The 


302         MISCELLANEOUS  ACCOUNTING  TOPICS 

contingent  asset  consists  of  a  right  to  hold  the  maker  of 
the  note,  if  the  indorser  is  obliged  to  pay  it,  and  of 
course  this  right  disappears  when  the  maker  pays  the 
note.     The  journal  entry  would  be: 

Notes  Receivable  Discounted $ 

To  Notes  Receivable $ 


11.     Bookkeeping  for  Dishonored  Discounted  Note 

If  a  discounted  note  is  dishonored  by  its  maker,  the 
person  who  discounted  it  must  pay  the  face  of  the  note 
and  the  expense  of  protest.  This  will  be  a  credit 
to  Cash.     The  debits  should  be  made  as  follows. 

Since  the  face  of  the  note  represents  a  contin- 
gent liability  in  the  Notes  Receivable  Discounted  ac- 
count and  since  this  liability  has  now  become  an  actual 
one,  that  account  should  be  debited  with  the  face  of 
the  note  to  record  the  payment  of  the  liability.  The 
protest  fee  should  be  charged  to  the  personal  account 
of  the  maker  of  the  note  because  this  expense  has  been 
incurred  through  his  failure  to  meet  his  obligation.  At 
the  same  time  a  journal  entry  should  be  made  charg- 
ing to  the  maker's  personal  account  the  face  of  the  note 
and  crediting  Notes  Receivable.  The  maker's  account 
will  then  show  the  total  amount  due  from  him.  If  this 
account  should  prove  to  be  uncollectible,  it  can  be  closed 
out  like  any  other  worthless  account  receivable. 

There  would  be  no  justification  for  charging  the 
maker  with  the  discount  paid  upon  the  sale  of  the  note 
by  the  original  payee  because  such  discount  is  an  ex- 
pense incurred  by  the  latter  for  the  use  of  money.  The 
maker  is  not  in  any  way  responsible  for  his  discounting 
the  note. 


NOTES  AND  TRADE  ACCEPTANCES  308 

12.    Note  Register 

Where  it  is  the  practice  to  issue  and  receive  many 
notes,  a  note  register  should  be  employed  in  which  to 
record  them.  Such  a  register,  purchasable  at  any  sta- 
tionery store,  provides  pages  so  ruled  as  to  show  dates, 
names,  interest  rates,  amounts,  maturities,  and  all  other 
facts  needed  for  a  complete  record.  These  books  are 
frequently  made  so  that  one-half  may  be  used  for  notes 
receivable  and  the  other  half  for  notes  payable. 

In  using  such  a  register  it  is  customary  to  enter  all 
notes  in  the  order  in  which  they  are  received  or  issued, 
starting  a  new  page  for  each  month.  Under  this 
method  the  total  of  the  notes  for  the  month  may  be 
posted  to  the  ledger  account  in  one  amount  instead  of 
individually.  The  total  of  the  notes  paid  during  a  month 
may  likewise  be  posted  at  the  end  of  each  month,  each 
payment  being  noted  currently  in  the  register. 

Another  method  of  operating  the  register  possesses 
certain  advantages.  Instead  of  entering  the  notes  in 
the  order  received  or  issued,  they  may  be  entered  in 
the  order  of  their  maturity;  and  in  lieu  of  a  page  for 
all  notes  received  or  issued  during  a  month  a  separate 
page  may  be  used  for  all  notes  maturing  each  month. 
One  page  will  then  contain  all  notes  maturing  in  Jan- 
uary, another  all  those  maturing  in  February,  and  so 
on.  This  arrangement  shows  at  a  glance  how  mud 
will  be  received  or  paid  on  notes  during  any  one  month 
and  thus  is  an  aid  in  the  financial  management  of  the 
business.  If  this  method  is  employed,  the  page  for 
each  month  should  have  a  summary  at  the  bottom  of  all 
notes  received  or  issued  during  that  month  so  that  post- 
ings may  be  made  in  total  as  under  the  other  method. 


304         MISCELLANEOUS  ACCOUNTING  TOPICS 

13.  Bookkeeping  for  Notes  Payable 

No  comment  on  the  bookkeeping  for  notes  payable 
is  needed  because  it  resembles  that  for  notes  receivable, 
except,  of  course,  the  entries  are  reversed.  Notes  receiv- 
able discounted  should  not  be  merged  with  notes  pay- 
able, because  the  latter  are  actual  liabilities  while  the 
former  are  only  contingent  liabilities  which  rarely  be- 
come actual.  It  is  obvious  that  notes  payable  and  notes 
receivable  should  not  be  kept  in  one  account  and  yet 
accountants  in  public  practice  not  infrequently  meet 
with  such  amateurish  bookkeeping. 

14.  Trade  Acceptances 

A  trade  acceptance  is  an  accepted  bill  of  exchange 
or  draft  based  upon  an  actual  transaction  in  trading. 
Drafts  can  be  drawn  and  accepted  for  accommodation 
or  for  cash  or  for  any  other  consideration;  but  to  con- 
stitute a  trade  acceptance  the  draft  should  have  noth- 
ing to  do  with  any  transactions  except  those  concerning 
the  purchase  and  sale  of  merchandise.  If  such  trade 
acceptances  meet  the  requirements  of  the  Federal  Re- 
serve Board  they  may  be  rediscounted  by  banks  and 
thus  approximate  the  negotiability  of  currency. 

Formerly  trade  acceptances  were  in  common  use  in 
this  country;  but  at  the  close  of  the  Civil  War  there 
was  so  great  a  demand  for  cash  and  the  banking  facil- 
ities were  so  poorly  adapted  for  the  discounting  of 
drafts  that  promissory  notes  and  other  forms  of  "one- 
name"  paper  forced  the  trade  acceptance  out  of  general 
use.  It  has  been  argued  (in  many  cases  by  authorities) 
that  this  form  of  credit  instrument  might  with  advantage 
be  more  generally  adopted.   The  seller  of  merchandise 


NOTES  AND  TRADE  ACCEPTANCES      305 

would  be  benefited  because  at  the  time  a  sale  is  made 
all  questions  of  price  and  credit  would  be  settled  and 
the  collection  of  the  account  would  be  reduced  to  a 
matter  of  routine.  The  buyer  by  giving  a  trade  accept- 
ance acknowledges  the  correctness  of  the  account;  the 
seller,  by  being  able  to  discount  the  acceptance,  avoids 
any  reduction  of  his  working  capital  due  to  carrying 
the  account  receivable.  The  trade  acceptance  would 
benefit  the  buyer's  credit.  Since  he  expects  it  to  be 
negotiated  he  would  not  be  likely  to  overbuy  as  he  must 
be  prepared  to  meet  his  acceptances  as  they  become  due. 
His  credit  standing  in  the  community  would  be  estab- 
lished. 

15.    Bookkeeping  for  Trade  Acceptances 

No  entry  should  be  made  for  a  draft  of  any  sort 
until  it  has  been  accepted;  then  it  should  be  recorded 
like  a  note  receivable  or  payable.  In  fact,  a  trade  ac- 
ceptance differs  from  a  note  only  in  that  two  persons 
are  involved  in  the  transaction;  the  difference  there- 
fore is  one  of  security  and  not  of  accounting. 


CHAPTER   XXVIII 

ILLUSTRATIVE   NOTE   TRANSACTIONS 
JOURNALIZED 

1.     Use  of  Additional  Columns 

As  explained  in  a  preceding  chapter,  the  journal 
was  probably  the  only  book  of  original  entry  at  first 
employed.  When  it  was  noted  that  cash  transactions 
exceeded  in  number  all  others,  such  transactions  were 
taken  out  of  the  journal  and  given  a  separate  book  of 
original  entry,  known  as  the  cash  book.  The  next  step 
in  the  development  of  the  journal  was  to  remove  from 
it  the  transactions  relating  to  purchases  and  sales, 
recording  them  respectively  in  purchase  journals  and 
sales  journals. 

In  the  ordinary  business  the  only  transactions  re- 
maining to  be  recorded  in  the  journal  are  opening,  clos- 
ing, and  adjusting  entries.  In  some  businesses,  how- 
ever, the  accounts  receivable  and  the  accounts  payable 
are  sufficiently  numerous  to  require  controlling  ac- 
counts, and  also  there  are  many  current  transactions  in 
notes  receivable  and  notes  payable.  Under  these  cir- 
cumstances, the  general  journal  may  conveniently  be 
columnarized  in  the  form  shown  in  §  3.  By  the  use  of 
a  column  each  for  the  debits  and  the  credits  to  the 
controlling  accounts  of  Accounts  Receivable  and  Ac- 
counts Payable  and  of  Notes  Receivable  and  Notes 
Payable,  with  an  additional  column  each  for  the  debits 
and  credits  to  the  miscellaneous  accounts,  the  general 

306 


NOTE  TRANSACTIONS  JOURNALIZED  307 

journal  becomes  virtually  a  combination  of  five  jour- 
nals. Entries  can  conveniently  be  made  in  it  for  post- 
ing in  detail  to  the  miscellaneous  accounts  in  the  gen- 
eral ledger  and  for  the  collection  of  monthly  totals  to 
be  posted  to  the  controlling  accounts  for  accounts  re- 
ceivable and  accounts  payable  and  to  the  accounts  for 
notes  receivable  and  notes  payable. 

2.     Illustrative  Transactions 

In  order  to  present  more  clearly  the  use  of  such  a 
columnar  journal  as  that  described  above,  a  set  of  illus- 
trative transactions  is  presented  herewith.  This  is  fol- 
lowed by  a  proper  way  of  recording  them  shown  in 
Form  12. 

Sept.  1.  Arthur  N.  Carey  invests  the  following  in  a  gen- 
eral retail  store:  cash  $1,427.80;  merchandise 
$1,370;  furniture  and  fixtures  $525.50;  store 
and  lot  $5,000;  notes  and  drafts  due  him 
$765.40;  notes  outstanding  $895.80;  accounts 
due  him  $1,427.50;  accounts  outstanding 
$329.50. 

3.  Receives  of  Robert  Watkins  on  account  his  note 

for  $250  at  60  days,  with  interest  at  6%. 

4.  Gives  Harold  Avery  on  account  Clifford  Reed's 

60-day  sight  draft  for  $500,  dated  seven  days 
ago  and  accepted  four  days  ago,  less  discount 
at  6%. 

6.  Receives  from  George  Bay  on  account,  less  dis- 

count at  6%,  Kay  Bros,  acceptance  for 
$945.10,  dated  August  4,  at  90  days  sight  and 
accepted  six  days  ago. 

7.  Gives  James  Johnson  on  account  Morton  Collins' 

note  dated  20  days  ago,  at  90  days,  with  inter- 
est at  6%,  for  $385.25  less  discount. 


308         MISCELLANEOUS  ACCOUNTING  TOPICS 

9.  Martin  Best's  account  for  $285.76  is  due  today 
and  a  draft  is  drawn  at  sight  on  him,  less  mer- 
chandise discount  at  2%  in  favor  of  Charles 
Harlan  to  apply  on  account. 

3.      Illustrative  Form  of  Journal 

The  following  form  of  journal  contains  the  record 
of  the  preceding  transactions,  the  necessary  explana- 
tions of  those  which  are  not  entirely  clear  appearing  in 
§4. 

Attention  is  invited  to  the  headings  of  the  columns 
in  the  journal  form.  In  practice  a  six-column  journal 
with  the  explanation  space  in  the  center  may  be  pur- 
chased from  a  stationer  and  the  headings  inserted  in  ink. 
In  many  cases,  however,  it  is  possible  to  predetermine 
the  exact  rulings  required  and  it  then  becomes  more 
convenient  to  have  a  book  made  to  order,  with  the  col- 
umn headings  printed.  It  will  be  noted  that  the  columns 
are  arranged  to  accommodate  the  majority  of  usual 
transactions.  For  example,  Notes  Receivable  account  has 
a  column  on  the  debit  side  of  the  journal  because  prac- 
tically all  transactions  relating  to  that  account  which 
would  be  entered  in  the  journal  would  require  debits  to 
that  account,  the  credits  to  that  account  being  chiefly 
for  collection  of  notes  receivable,  which  collections  would 
be  entered  in  the  cash  book.  The  same  comment  applies 
to  the  Accounts  Payable  account.  On  the  credit  side  of 
the  journal  a  column  is  provided  for  Accounts  Receiv- 
able account  because  most  of  the  debits  to  that  account 
would  be  made  through  a  sales  book.  A  credit  column 
for  notes  payable  is  the  only  one  needed  in  the  journal 
because  the  debits  to  that  account  would  ordinarily  be 
entered  in  the  cash  book. 


NOTE  TRANSACTIONS  JOURNALIZED 


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310         MISCELLANEOUS  ACCOUNTING  TOPICS 
4.     Comment  on  Transactions 

September  1.  The  entry  under  this  date  opens  the 
new  set  of  books  by  debiting  accounts  for  assets,  credit- 
ing accounts  for  liabilities,  and  crediting  the  excess  of 
assets  over  liabilities  to  the  proprietor's  capital  account. 
It  will  be  noted  that  the  amounts  of  notes  receivable  and 
of  notes  payable  are  entered  as  one  item  without  specify- 
ing the  individual  notes  which  compose  the  total.  The 
details  of  these  amounts  can  be  entered  in  the  ledger  ac- 
count, giving  one  line  to  each  note,  but  the  usual  prac- 
tice is  to  keep  the  details  of  notes  both  receivable  and 
payable  in  a  note  register,  which  has  columns  to  record 
information  concerning  each  note,  such  as  its  maturity 
date,  rate  of  interest,  indorsers,  and  the  like.  Upon 
opening  a  new  set  of  books,  it  is  desirable  to  incorporate 
in  the  opening  journal  entry  a  detailed  list  of  notes  re- 
ceivable and  payable  to  serve  as  a  check  upon  the  cor- 
rectness of  the  total.  Where  the  notes  are  not  numerous, 
they  may  be  itemized  in  the  body  of  the  entry.  If  they 
are  numerous,  it  is  sometimes  convenient  to  paste  into 
the  journal  an  adding  machine  list  showing  the  amounts 
of  the  notes  with  sufficient  description  opposite  each 
item  to  identify  the  note.  The  same  comment  applies 
to  the  total  of  accounts  receivable  and  accounts  payable. 

3.  The  fact  that  this  note  bears  interest  at  6%  does 
not  affect  the  present  entry,  which  is  a  debit  to  Notes 
Receivable  and  a  credit  to  the  customer,  of  the  face  value 
of  the  note.  As  explained  in  a  preceding  chapter,  it  is 
more  convenient  to  record  in  Note  accounts  only  the  face 
values  of  notes,  leaving  interest  and  discount  adjust- 
ments to  be  made  in  other  accounts.  In  the  case  under 
discussion,  when  the  note  becomes  due  and  the  interest 


NOTE  TRANSACTIONS  JOURNALIZED  3H 

is  collected  thereon,  the  amount  of  such  interest  will  be 
credited  to  an  Interest  account,  the  face  of  the  note  being 
credited  to  Notes  Receivable.  If  any  collection  charges 
are  incurred  they  should  be  debited  to  an  appropriate 
expense  account. 

4.  This  transaction,  more  simply  stated,  means  that 
Carey  gave  a  60-day  sight  draft  for  $500  to  Avery  in 
part  settlement  of  an  amount  due  to  Avery.  The  draft 
as  drawn  on  Reed  and  accepted  by  him  was  already  in 
Carey's  possession  and  must  have  been  recorded  among 
his  notes  receivable,  there  being  no  fundamental  dis- 
tinction between  a  note  receivable  and  an  accepted  draft. 
Consequently,  the  transfer  of  this  draft  by  Carey  to 
Avery  requires  the  crediting  of  a  Notes  Receivable  Dis- 
counted account  with  its  face  value,  $500.  Avery's  ac- 
count, however,  cannot  be  debited  with  $500  because 
the  draft  is  not  immediately  collectible  and  it  is  neces- 
sary to  allow  Avery  a  credit  for  the  interest  on  this 
amount  prior  to  the  time  when  he  can  collect  it.  Conse- 
quently, Avery's  account  is  debited  with  $495.33  and 
the  interest  or  discount  of  $4.67  is  debited  to  a  Discount 
account.  The  reason  for  crediting  Notes  Receivable 
Discounted  instead  of  Notes  Receivable  is  explained  in 
Chapter  XXVII.  If  the  discounting  of  notes  and  ac- 
cepted drafts,  either  to  banks  or  with  customers,  was  of 
frequent  occurrence,  it  would  be  convenient  to  open  a 
credit  column  in  the  journal  for  notes  receivable  dis- 
counted. A  fundamental  principle  underlying  the  pro- 
viding of  special  columns  is  that  there  must  be  a  suffi- 
cient number  of  entries  to  justify  the  use  of  the  column. 
Where  the  entries  are  not  likely  to  exceed  two  or  three 
each  month,  a  special  column  is  not  required.   It  will  be 


312         MISCELLANEOUS  ACCOUNTING  TOPICS 

noted  incidently  that  the  discount  deducted  from  the 
face  of  the  draft  is  interest  for  the  unexpired  time  on 
the  draft  and  not  for  its  entire  life.  Carey  cannot 
properly  charge  Avery  with  the  interest  on  the  draft 
while  it  was  in  Carey's  possession. 

6.  This  transaction  indicates  that  Carey  receives 
from  his  customer  Bay  a  draft  for  $945.10,  accepted  by 
Kay  Bros.,  payable  90  days  after  sight.  The  entry  of 
this  transaction  is  practically  the  reverse  of  the  preced- 
ing one.  Notes  Receivable  account  is  debited  for  the 
face  value  of  the  draft  but  the  customer  is  credited  with 
only  $931.87;  interest  on  the  draft  for  its  unexpired 
time,  $13.23,  being  credited  to  an  income  account  for 
discount.  When  the  draft  is  paid  by  the  acceptor,  Kay 
Bros.,  Carey  will  receive  the  face  value  or  $13.23  more 
than  the  amount  credited  to  the  customer  Bay.  This 
$13.23  is  therefore  an  income  representing  the  interest 
earned  through  the  allowance  of  a  credit  to  the  customer 
prior  to  the  receipt  of  money  from  him.  In  other  words, 
it  is  a  charge  made  by  Carey  for  the  extension  of  credit 
to  Bay. 

7.  This  transaction  also  involves  the  settlement  of 
an  account  payable  by  the  transfer  or  discounting  of  a 
note  receivable.  There  is  one  new  element,  namely,  the 
fact  that  the  discounted  note  bears  interest.  This  inter- 
est will  be  collected  at  the  maturity  of  the  note,  with 
the  result  that  the  creditor  must  be  debited  with  more 
than  the  face  value.  The  creditor  is  charged  with  the 
total  proceeds  of  the  note,  consisting  of  its  face  value  and 
interest  thereon  less,  however,  the  interest  or  discount 
on  that  amount  for  the  unexpired  time  of  the  note.  The 
credit  for  the  face  of  the  note  is  made  to  Notes  Receiv- 


NOTE  TRANSACTIONS  JOURNALIZED  313 

able  Discounted  for  reasons  explained  in  Chapter 
XXVII,  and  an  additional  credit  to  an  income  account 
for  interest  is  made  to  record  the  interest  earned  by 
Carey  on  the  note. 

9.  The  transaction  under  this  date  involves  three 
distinct  entries.  The  facts  are  that  Best,  who  is  a  cus- 
tomer of  Carey's,  owes  $285.76  but  is  entitled  to  a  mer- 
chandise discount  of  2%,  or  $5.72.  This  amount  accord- 
ingly is  debited  to  Discount  on  Sales  and  credited  to 
Best,  leaving  Best  indebted  for  $280.40.  A  draft  is 
drawn  on  Best  for  this  amount  and  turned  over  to  a 
creditor,  Harlan,  on  account  of  an  amount  due  Harlan. 
In  order  to  record  the  acceptance  by  Best  of  the  draft 
drawn  on  him,  an  entry  is  made  debiting  Notes  Receiv- 
able and  crediting  Best  with  the  face  value  of  the  draft. 
The  transfer  of  the  draft  to  Harlan  is  recorded  by  debit- 
ing Harlan  and  crediting  Notes  Receivable  Discounted. 

5.     Monthly  Closing  Entries 

The  totals  of  the  debit  columns  for  notes  receivable 
and  accounts  payable  and  of  the  credit  columns  for  ac- 
counts receivable  and  notes  payable  may  be  entered  in 
the  general  columns  of  the  journal  for  posting  respec- 
tively to  the  debit  and  credit  of  these  accounts.  This 
procedure  is,  however,  somewhat  formal  and  in  modern 
practice  it  is  customary  to  debit  and  credit  the  four  ac- 
counts involved  directly  from  the  totals  of  the  columns 
in  the  journal.  This  latter  procedure  has  been  followed 
in  the  illustration  shown  in  Form  12. 

It  will  be  noted  that  a  total  is  shown  for  the  gen- 
eral column  on  each  side  of  the  journal.  No  use  of  this 
total  is  made  in  posting  because  each  item  in  each  gen- 


314         MISCELLANEOUS  ACCOUNTING  TOPICS 

eral  column  is  posted  in  detail,  but  it  is  convenient  in 
using  a  columnar  journal  to  have  all  columns  added  so 
that  the  total  debits  can  readily  be  shown  to  equal  the 
total  credits  made  from  the  journal. 


CHAPTER    XXIX 
DEPRECIATION 

1.  Definition  of  Depreciation 

Depreciation  is  the  shrinkage  in  value  of  a  fixed 
asset  due  to  its  possession  and  use.  Current  assets  also 
may  depreciate,  but  no  accounting  record  is  made  of  it 
because  such  assets  are  intended  for  sale  and  any  shrink- 
age in  their  value  will  be  immediately  reflected  in  the 
profit  or  loss  on  that  turnover.  Fixed  assets,  on  the 
other  hand,  are  not  sold  but  are  retained  in  the  business. 
In  the  course  of  time  it  will  be  necessary  to  replace 
them,  and  such  replacements  do  not  increase  the  total 
value  of  all  assets  in  the  business.  Therefore,  the  cost 
of  such  replacements  is  an  expense  of  the  business.  As 
this  expense  is  not  incurred  at  the  moment  the  replace- 
ment is  made  but  occurs  gradually,  it  is  advisable  to  pro- 
vide for  it  periodically  so  that  the  amount  applicable  to 
each  fiscal  period  may  be  ascertained.  Such  shrinkage  in 
value  is  known  as  depreciation,  and  in  this  chapter  the 
causes  of  depreciation  and  the  accounting  methods  of 
recording  it  will  be  discussed  in  an  elementary  way. 

2.  Causes  of  Depreciation 

There  are  three  principal  causes  of  depreciation:  (1) 
wear  and  tear,  (2)  lapse  of  time,  and  (3)  obsolescence. 

Wear  and  tear  is  obviously  a  cause  of  depreciation. 
A  machine,  for  example,  will  gradually  wear  out.  Lapse 
of  time,  while  not  so  obviously  a  cause,  will  neverthe- 

315 


316         MISCELLANEOUS  ACCOUNTING  TOPICS 

less  produce  depreciation.  Continuing  the  example,  if 
machinery  is  not  used  at  all  it  still  will  depreciate  merely 
from  age;  in  fact,  some  types  of  machinery  depreciate 
more  rapidly  when  not  used  to  a  normal  extent  than 
when  they  are  so  used. 

Depreciation  due  to  obsolescence,  which  means  the 
state  of  becoming  obsolete,  is  the  most  difficult  shrink- 
age for  which  to  make  provision.  A  fixed  asset  becomes 
obsolete  when  it  is  inadequate  to  meet  the  present  need 
of  the  business  or  when  some  newer  and  better  machine 
has  been  invented.  Occasionally  a  fixed  asset  will  be- 
come obsolete  practically  at  once  but  some  provision 
should  be  made  currently  to  anticipate  such  a  condition 
and  it  is  customary  to  regard  obsolescence  as  a  gradual 
process. 

3.      Kinds  of  Depreciation 

There  are  fundamentally  two  kinds  of  depreciation 
— physical  and  functional.  Physical  depreciation  is  a 
reduction  in  the  intrinsic  value  of  the  asset  itself  and  is 
due  to  wear  and  tear  and  lapse  of  time.  Functional  de- 
preciation is  due  to  the  inadequacy  or  obsolescence  of 
the  asset  although  the  asset  may  be  in  practically  per- 
fect condition  from  a  physical  point  of  view.  Depreci- 
ation on  a  street-car  will  illustrate  this.  The  car  depre- 
ciates physically  by  wearing  out;  it  depreciates  func- 
tionally by  becoming  inadequate  for  the  service  required 
of  it,  due,  for  example,  to  increased  traffic. 

Both  kinds  of  depreciation,  physical  and  functional, 
are  continually  occurring.  In  any  particular  case  the 
question,  which  kind  of  depreciation  occurs  faster,  is  an 
engineering  matter  concerning  which  considerable  dif- 


DEPRECIATION  317 

ference  of  opinion  exists.  Some  engineers  have  gone  so 
far  as  to  maintain  that  functional  depreciation  is  the 
only  kind  which  need  be  considered,  because  before 
physical  depreciation  has  rendered  the  asset  useless  the 
asset  will  have  become  obsolete  or  inadequate  and  ac- 
cordingly will  be  replaced  for  economic  reasons.  In 
other  words,  their  position  is  that  in  practically  every 
case  the  purchase  of  more  modern  or  more  adequate 
equipment  becomes  advisable  before  the  original  equip- 
ment is  worn  out. 

These  questions  lie  chiefly  in  the  field  of  engineering 
and  therefore  do  not  concern  accountants  in  general  busi- 
ness practice  to  any  great  extent.  The  important  thing 
for  the  accountant  to  know  is  that  provision  must  be 
made  currently  for  depreciation  regardless  of  its  cause. 

4.      Bookkeeping  for  Depreciation 

Since  depreciation  is  a  shrinkage  in  asset  value,  it 
would  be  logical  to  credit  it  to  the  account  for  the  asset 
to  which  it  applies.  This  is  based  on  the  rules  for  jour- 
nalizing given  in  Chapter  XV,  which  direct  that  an  asset 
account  should  be  credited  to  record  a  decrease  in  the 
asset.  As  a  matter  of  practice,  it  is  not  convenient  to 
credit  the  asset  account  directly  because  such  procedure 
would  make  the  account  unduly  complicated.  An  asset 
account  should  be  debited  with  the  cost  of  the  asset  when 
it  is  acquired,  and  should  be  credited  only  with  the  cost 
of  such  asset  when  it  is  retired  from  service.  The  credit 
for  depreciation,  instead  of  being  made  in  the  asset  ac- 
count, should  be  made  in  a  so-called  reserve  account  con- 
taining, as  explained  in  Volume  IV,  suspended  credits 
which  might  logically  be  made  in  the  asset  account  itself. 


518         MISCELLANEOUS  ACCOUNTING  TOPICS 

A  further  practical  advantage  which  results  from 
crediting  the  depreciation  to  a  so-called  reserve  account 
is  that  upon  any  loss  against  which  insurance  is  carried, 
the  original  cost  of  the  asset  is  clearly  set  forth  in  the 
asset  account  and  the  amount  of  depreciation  is  con- 
fined to  a  reserve  for  depreciation  account  and  thus  ear- 
marked for  adjustment  with  the  insurance  company. 

The  journal  entry  for  depreciation  of  an  asset,  tak- 
ing machinery  as  an  example,  would  therefore  be  as 
follows : 

Depreciation   $ 

To  Reserve  for  Depreciation $ 


The  depreciation  account  is  purely  nominal,  repre- 
senting a  manufacturing  expense,  and  accordingly 
would  be  closed  into  the  Profit  and  Loss  account.  The 
reserve  for  depreciation  appears  as  a  credit  balance  on 
the  ledger,  but  on  the  balance  sheet  it  should  be  deducted 
from  the  book  value  of  the  asset  to  which  it  applies,  leav- 
ing for  the  extension  the  net  or  actual  value  of  the  asset. 

It  is  desirable  to  have  a  reserve  for  depreciation  ac- 
count for  each  kind  of  depreciable  asset  so  that  these  de- 
ductions can  easily  be  made  for  balance  sheet  purposes 
and  proper  attention  given  to  fixing  rates  of  deprecia- 
tion. Where  \here  is  but  one  reserve  for  depreciation 
covering  all  fixed  assets,  there  is  likely  to  be  a  tendency 
to  guess  at  the  amount  of  it  or  to  fix  some  arbitrary  rate 
which  has  no  direct  connection  with  the  actual  facts  of 
depreciation.  It  is  evident  that  a  stone  building,  for 
example,  will  not  depreciate  as  rapidly  as  a  frame  one. 
If  there  is  a  separate  reserve  for  depreciation  account 
for  each  kind  of  building,  the  actual  facts  of  deprecia- 


DEPRECIATION  319 

tion  are  likely  to  be  more  nearly  approximate  in  the 
determination  of  the  current  charge. 

5.     Bookkeeping  for  Replacements 

Upon  the  original  purchase  of  a  fixed  asset,  machin- 
ery for  example,  the  journal  entry  would  be: 

Machinery $ 

To  Cash  (or  Accounts  Payable) $ 

As  depreciation  is  periodically  provided  for,  the  entry 
would  be : 

Depreciation    $ 

To     Reserve     for     Depreciation     of 

Machinery $ 

Assume  now  that  the  asset  has  completed  its  useful 
life  and  needs  to  be  replaced.  If  it  has  a  residual  or  scrap 
value,  i.e.,  if  it  can  be  sold  for  something,  a  sales  ac- 
count should  be  opened  and  charged  with  the  book  value 
of  the  machinery.  The  entry  for  this  would  be : 

Sale  of  Machinery $ 

To  Machinery $ 

This  entry  will  record  the  retirement  of  the  machinery 
by  crediting  its  original  cost. 

The  debit  to  Sale  of  Machinery  account  will  not, 
however,  give  the  actual  book  value  of  the  machinery, 
because  there  has  been  an  accumulation  of  credits  for 
depreciation  which  have  been  temporarily  suspended  in 
the  Reserve  for  Depreciation  account.  This  reserve  ac- 
count should  therefore  be  closed  into  the  Sale  of  Machin- 
ery account  so  as  to  leave  the  latter  debited  with  the 


320         MISCELLANEOUS  ACCOUNTING  TOPICS 

present  book  value  of  the  asset  to  be  sold.  The  entry  to 
accomplish  this  is  the  following: 

Reserve  for  Depreciation  of  Machinery $ 

To  Sale  of  Machinery $ 


The  amount  received  for  the  machinery  upon  its  sale 
as  scrap  or  second-hand  equipment  should  be  debited  to 
Cash,  Accounts  Receivable,  or  any  other  asset  affected, 
and  credited  to  Sale  of  Machinery  account.  This  will 
usually  leave  a  balance  in  the  latter  account.  This  bal- 
ance, if  a  credit,  represents  a  profit,  and  if  a  debit,  rep- 
resents a  loss.  It  should  be  closed  at  once  into  the 
Capital  account  because  it  shows  an  increase  or  decrease 
in  capital  not  due  to  the  operation  of  the  business  and 
therefore  not  properly  belonging  in  the  Profit  and  Loss 
account. 

Upon  the  purchase  of  new  machinery  which  is  to 
replace  that  which  was  retired,  the  entry  would  be : 

Machinery $ 

To  Cash  (or  Accounts  Payable)  ....  $ 


A  fixed  asset  account  should  be  so  kept  as  to  identify 
the  asset  which  has  been  charged  to  it.  If  a  machine 
has  a  manufacturer's  number  or  if  it  can  be  identified  in 
some  other  way,  this  number  or  mark  of  identification 
should  be  entered  in  the  explanation  space  of  the  machin- 
ery account  in  the  ledger.  Costs  in  wages,  material,  and 
supplies  incurred  in  installing  or  making  the  machinery 
ready  for  use  should  also  be  debited  to  the  Machinery 
account  and  identified  with  the  particular  machine  in- 
stalled. When  such  machine  is  retired  from  service  the 
credit  entry  should  include  the  installation  costs  and 
should  identify  the  machine  so  that  an  inspection  of  the 


DEPRECIATION  821 

account  will  indicate  the  machines  on  hand.    They  can 
then  be  inspected  if  verification  of  the  account  is  needed. 

6.      Determination  of  Depreciation  Rate 

The  depreciation  rate  is  usually  a  percentage  of  cost 
which  is  to  be  used  each  year  in  calculating  the  amount 
chargeable  for  current  depreciation.  In  fixing  the  rate 
three  fundamental  facts  must  be  determined,  viz.,  the 
original  cost  of  the  asset,  the  probable  life  of  the  asset, 
and  its  residual  value.  Although  all  three  of  these  items 
were  called  "facts,"  it  is  evident  that  only  the  first,  the 
original  cost,  is  actually  a  fact.  The  probable  life  of  the 
asset  and  its  residual  value  are  very  largely  matters  of 
judgment.  If  the  asset  is  machinery  or  anything  of  a 
technical  nature,  it  is  necessary  to  secure  engineering 
judgment  upon  the  matter  and  the  accountant  or  busi- 
ness man  is  rarely  competent  to  form  a  judgment.  In 
the  simpler  problems  of  depreciation,  for  example  that 
concerning  office  furniture  and  fixtures,  any  intelligent 
person  can  form  a  reasonable  opinion. 

In  the  determination  of  the  probable  life  of  an  asset, 
the  assumption  is  made  that  it  will  be  maintained  in 
proper  working  condition  by  repairs  and  replacements 
of  small  parts  as  they  become  worn  out,  for  it  is  obvious 
that  if  an  asset  is  not  properly  maintained  it  will  depre- 
ciate much  more  rapidly  than  it  otherwise  would. 

By  deducting  the  residual  value  from  the  original 
cost  of  the  asset  the  net  depreciable  investment  is  de- 
termined. This  is  the  amount  which  must  be  written  off 
gradually  during  the  probable  life  of  the  asset  in  order 
to  make  each  fiscal  period  bear  its  proper  portion  of  the 
loss  due  to  depreciation.    There  are  three  common  or 


322         MISCELLANEOUS  ACCOUNTING  TOPICS 

standard  methods  of  fixing  the  rate  to  be  used  in  writing 
off  depreciation,  namely :  ( 1 )  straight-line  method,  ( 2 ) 
fixed-percentage-of -diminishing- value  method,  and  (3) 
sinking-fund  method. 

7.  Straight-Line  Method 

Under  the  straight-line  method  the  net  depreciable 
investment  is  divided  by  the  number  of  years  of  life  of 
the  asset  to  get  equal  annual  charges.  Assuming  an 
asset  which  cost  $100  with  no  residual  value  and  a  life 
of  25  years,  the  straight-line  method  calls  for  an  annual 
charge  of  $4.  This  method  is  called  the  straight-line 
method  because  if  a  curve  is  plotted  showing  the  total  de- 
preciation year  after  year,  the  points  in  this  curve  if  con- 
nected will  form  a  straight  line.  This  is  the  simplest 
method  because  it  does  not  consider  interest  as  an  ele- 
ment. In  view  of  the  fact  that  both  the  probable  life 
and  the  residual  value  are  so  largely  matters  of  judg- 
ment, this  method  is  usually  as  satisfactory  and  as  likely 
to  give  results  which  conform  to  the  facts  of  deprecia- 
tion as  any  of  the  more  complicated  methods. 

8.  Fixed-Percentage-of-Diminishing- Value  Method 

Under  this  method  a  fixed  percentage  of  the  balance 
of  the  asset  account  is  written  off  each  period,  to  reduce 
the  balance  of  the  account  to  the  residual  value  of  the 
asset  at  the  termination  of  its  useful  life.  This  percent- 
age is  calculated  each  time  on  the  balance  of  the  original 
cost  of  the  asset  after  such  cost  has  been  reduced  by 
the  preceding  provision  for  depreciation.  It  is  evi- 
dent that  although  the  percentage  itself  is  fixed  the 
amount  of  the  annual  charge  will   decrease  because 


DEPRECIATION  gg3 

the  percentage  is  calculated  each  time  on  a  diminishing 
amount.  The  percentage  to  be  used  must  be  determined 
by  an  algebraic  formula.  An  explanation  of  the  mathe- 
matics involved  in  that  process  would  be  beyond  the 
scope  of  this  series,  but  formulas  can  be  found  in  various 
books  of  reference.* 

Applying  this  method  to  an  asset  which  cost  $100 
and  which  has  a  life  of  25  years  with  a  residual  value  of 
$1,  requires  a  constant  percentage  of  16.8236%.  The 
depreciation  charge  for  the  first  year  would  be  $16.82, 
reducing  the  original  cost  of  $100  to  $83.18.  Applying 
the  fixed  percentage  of  this  new  amount  gives  a  charge 
for  the  second  year  of  $13.99.  The  charge  for  the  tenth 
year  would  be  $2.67  and  for  the  twentieth  year  will  be 
42  cents.  At  the  end  of  the  twenty-fifth  year  the  original 
cost  will  have  been  reduced  to  $1,  and  $99  will  have 
been  written  off  for  depreciation. 

The  principal  argument  in  favor  of  this  method  is 
that  it  tends  to  make  the  total  expense  of  carrying  the 
asset  uniform  throughout  its  life,  because  such  expense 
includes  not  only  depreciation  but  also  repairs  and  main- 
tenance. Although  the  charge  for  depreciation  decreases 
from  a  heavy  amount  in  the  first  years  to  practically 
nothing  in  the  later  years,  the  cost  of  repairs  and  main- 
tenance increases  throughout  the  life  of  the  asset.  Ac- 
cordingly it  is  claimed  that  the  annual  charge  for  de- 
preciation together  with  the  expense  of  repairs  and 
maintenance  will  make  a  fairly  uniform  total  through- 
out the  life  of  the  asset.  This  method  finds  favor  among 
many  accountants  and  engineers,  although  it  is  unlikely 
that  any  asset  depreciates  so  rapidly  in  its  first  years. 

•For  example,  "Principles  of  Depreciation,"  by  E.  A.   Salieri. 


324         MISCELLANEOUS  ACCOUNTING  TOPICS 

This  method  cannot  logically  be  applied  to  an  asset 
which  has  no  residual  value  for  the  mathematical  reason 
that  under  it  only  a  percentage  of  the  balance  is  written 
off  each  time,  which  necessarily  leaves  some  percentage 
remaining.  As  a  practical  matter,  however,  the  remain- 
ing percentage  would  be  reduced  to  a  negligible  figure. 

9.     Sinking  Fund  Method 

Under  the  sinking  fund  method  a  fixed  amount  of 
cash  is  set  aside  each  year  and  accumulated  at  compound 
interest  so  as  to  produce  the  amount  of  the  net  depreci- 
able investment  at  the  termination  of  the  life  of  the 
asset.  This  amount  of  cash  can  then  be  used  to  replace 
the  asset  which  has  depreciated.  The  determination  of 
the  fixed  amount  to  be  set  aside  periodically  involves 
mathematics  which  are  beyond  the  scope  of  this  volume, 
but  for  practical  purposes  the  required  amounts  can  be 
ascertained  from  sinking  fund  tables. 

While  the  amount  of  the  annual  cash  deposit  in  the 
sinking  fund  remains  fixed,  the  total  expense  or  charge 
for  depreciation  is  not  constant  because  the  business 
loses  interest  on  the  cash  deposits  in  the  sinking  fund. 
As  the  fund  accumulates,  this  loss  of  interest  increases 
and  accordingly  there  are  two  elements  to  be  considered 
in  fixing  the  charge  for  depreciation. 

For  an  asset  which  costs  $100  with  an  estimated 
life  of  25  years  and  no  residual  value,  the  fixed  annual 
deposit  for  the  sinking  fund  is  $2.0952.  Each  year 
$2.091/i>  must  be  deposited  in  the  fund.  The  total  of  such 
cash  deposits  at  the  end  of  the  25  years  will  be  $52.38. 
The  interest  accumulated  on  such  deposits  will  amount 
at  that  time  to  $47.62.    The  total  fund,  therefore,  will 


DEPRECIATION  325 

amount  to  $100,  which  is  the  sum  needed  to  replace  the 
depreciated  asset. 

Taking  into  consideration  the  loss  to  the  business  of 
interest  on  the  deposits  made,  the  annual  cost  or  charge 
for  depreciation  will  increase.  During  the  first  year  it 
will  be  $2.0952,  during  the  tenth  year  $3.4129,  and  dur- 
ing the  twentieth  year  $5.5593.  The  bookkeeping  to 
record  the  operation  of  such  fund  would  be  as  follows : 

Sinking  Fund .$ 

To  Cash $ 

(Amount  of  deposit) 

Depreciation   $ 

To  Reserve  for  Depreciation $ 

(Amount  of  deposit) 

Sinking    Fund $ 

To  Reserve  for  Depreciation $ 

(Interest  on  Sinking  Fund) 

Under  the  above  method  the  real  or  total  cost  to  the 
business  will  not  be  indicated.  The  annual  charge  for 
depreciation  includes  only  the  amount  of  the  cash  de- 
posited. There  is  an  additional  cost  in  the  loss  of  inter- 
est on  these  deposits,  and  this  additional  cost  should  be 
taken  into  consideration  before  the  adoption  of  this 
method.  In  fact,  the  principal  argument  against  it  is 
that  cash  should  be  retained  in  the  business  instead  of 
being  deposited  in  a  sinking  fund,  because  generally 
cash  is  worth  more  to  a  business  than  it  will  earn  as  a 
sinking-fund  investment. 

10.      Appreciation  of  Land 

Business  men  sometimes  argue  that  it  is  unnecessary 
to  provide  for  depreciation  if  land  is  owned,  because 


326         MISCELLANEOUS  ACCOUNTING  TOPICS 

land  will  appreciate  in  value  sufficiently  to  offset  all  de- 
preciation. Such  argument  is  fallacious.  If  land  in- 
creases in  value,  this  increase  will  result  in  increased 
sales  or  decreased  expenses.  In  either  event  the  increase 
in  the  operating  profit  will  reflect  the  increased  value  of 
the  land  to  the  business.  If  one  went  further  than  that 
and  recorded  also  an  increase  in  capital  to  offset  the  ap- 
preciation in  the  asset  land,  he  would  be  taking  this  in- 
crease in  land  into  consideration  twice.  An  estimated  in- 
crease in  the  market  value  of  land  should  not  be  recorded 
on  the  books  for  the  further  reason  that  land  is  a  fixed 
asset  and  not  intended  for  sale.  There  can  be  no  real 
profit  on  land  unless  it  is  actually  sold,  and  the  time  for 
taking  such  profit  into  the  accounts  is  after  a  sale  has 
been  made. 

Depreciation  should  not  be  confused  with  fluctua- 
tion. The  only  element  which  fluctuates  is  the  market 
price  of  an  asset.  The  original  cost  cannot  fluctuate. 
The  market  price  of  a  fixed  asset  has  no  bearing  upon 
its  value  to  the  business,  because  a  fixed  asset  is  not  in- 
tended for  sale  and  therefore  fluctuations  in  market 
value  in  either  direction  should  not  be  recorded  in  the 
accounts. 

11.     Provision  for  Bad  Debts 

A  provision  for  uncollectible  accounts  receivable  re- 
sembles one  for  depreciation  because  it  records  the  belief 
that  a  loss  has  taken  place  which  should  be  provided  for 
during  the  fiscal  period  in  which  it  occurred.  The  book- 
keeping for  recording  such  a  provision  is  similar  to  that 
for  recording  depreciation,  in  that  a  Reserve  for  Bad 
Debts  account  is  credited  and  Profit  and  Loss  debited. 


DEPRECIATION      ,  327 

This  so-called  reserve  should  be  deducted  from  the 
amount  of  accounts  receivable  in  the  preparation  of  a 
balance  sheet. 

Accounts  receivable  really  do  not  depreciate  in  the 
same  way  that  fixed  assets  depreciate.  Such  accounts  do 
not  gradually  waste  away  through  wear  and  tear  or 
lapse  of  time  or  obsolescence.  Sometimes  they  are 
worthless  from  their  inception  and  sometimes  they  be- 
come worthless  through  losses  or  accidents  sustained  by 
debtors.  The  provision  for  bad  debts  is  mentioned  in 
this  chapter  merely  because  it  somewhat  resembles  that 
for  depreciation  and  because  the  so-called  reserve  ac- 
count which  records  the  credit  to  offset  the  loss  is  treated 
in  the  same  way  as  the  so-called  reserve  for  deprecia- 
tion. In  fixing  the  amount  of  the  charge  to  be  made  for 
uncollectible  accounts  receivable,  the  amount  of  sales 
must  be  taken  into  consideration.  Past  experience  in 
each  business  will  indicate  approximately  the  percentage 
of  new  accounts  which  will  prove  uncollectible.  This 
percentage  of  current  charge  sales  should  be  debited  to 
Profit  and  Loss  and  credited  to  Reserve  for  Bad  Debts. 
Thereafter  as  individual  accounts  prove  worthless  they 
should  be  debited  to  the  Reserve  for  Bad  Debts. 


REVIEW  QUESTIONS 

1.  Define  depreciation. 

2.  Why  is  it  necessary  to  provide  for  it  in  the  accounts  ? 

3.  Which  method  of  calculating  depreciation  is  the  most  practical 

for  the  ordinary  business  ? 

4.  Should  appreciation  in  the  value  of  real  estate  be  recorded  in 

the  accounts  ? 

5.  How  should  provision  for  bad  debts  be  made? 


CHAPTER    XXX 

THE  USE  OF  SUBSIDIARY  BOOKS 
ILLUSTRATED 

1.      Columnar  Subsidiary  Books 

In  preceding  chapters  the  use  of  special  columnar 
books,  such  as  the  cash  book,  sales  book,  purchase  book, 
and  journal,  has  been  illustrated,  but  each  chapter  dealt 
with  a  single  book.  In  order  to  recapitulate  the  foregoing 
chapters  and  to  illustrate  the  recording  of  a  set  of  trans- 
actions in  all  the  books  of  original  entry  ordinarily  em- 
ployed in  a  small  business,  this  chapter  shows  the  entries 
in  four  books  of  original  entry  for  a  hypothetical  set  of 
facts  and  shows  the  preparation  of  a  trial  balance,  profit 
and  loss  statement,  and  balance  sheet  from  those  books. 

It  will  be  recalled  that  each  book  of  original  entry 
should  have  a  column  for  each  controlling  account  in 
the  general  ledger  and  for  each  general  ledger  account 
in  which  only  monthly  totals  would  be  of  interest.  For 
example,  the  cash  book  shown  in  Form  13  following 
contains  a  column  each  for  cash  sales  and  cash  pur- 
chases. These  two  accounts  in  the  general  ledger  show 
only  monthly  totals.  If  the  details  composing  the 
monthly  totals  are  desired,  such  details  can  readily  be 
ascertained  from  the  cash  book.  The  cash  book  con- 
tains a  column  for  accounts  receivable  and  for  accounts 
payable.  The  totals  of  these  two  columns  will  be  posted 
to  controlling  accounts  in  the  general  ledger,  which,  as 
explained  in  Chapter  XXIV,  will  agree  with  the  total  of 


SUBSIDIARY  BOOKS  ILLUSTRATED  !$2<) 

the  balances  in  a  customers  ledger  and  a  creditors  ledger 
respectively.  Thus  columns  in  a  book  of  original  entry 
may  be  utilized  both  for  controlling  accounts  and  for 
summary  accounts  which  need  contain  only  monthly 
totals. 

The  proper  use  of  these  numerous  columns  is  some- 
times perplexing  and  the  transactions  stated  in  §  2  are 
designed  to  furnish  the  necessary  practice.  It  is  sug- 
gested that  after  studying  the  original  entry  for  each 
transaction  the  necessary  ledger  account  be  opened  for 
its  final  record  and  that  postings  be  made  to  such  ac- 
counts from  each  book  of  original  entry.  The  correct- 
ness of  the  ledger  posting  work  can  then  be  verified  by 
means  of  a  trial  balance,  the  form  of  which  is  given  in 
§  5.  The  following  illustrative  transactions  are  recorded 
in  the  forms  shown  in  §  8. 

2.      Transactions  to  be  Recorded 

Oct.  1.    George  Clark  began  business  with  $8,500  cash. 
Paid  rent  in  advance  in  cash  $75. 
Paid   $527.31    for   counters,   shelving,  and   other   fixtures 

for  store  use. 
Bought  for  cash  miscellaneous   supplies  $21. 
Bought  merchandise  from  Andrew  Maxwell  on  account 
$3,878.95. 

2.  Paid  $40  for  advertisement  to  appear  in  daily  paper. 

3.  Bought  merchandise  of  Arthur  Harrison,  cash  $121.08. 

5.  Sold  Alfred  Carpenter  on  account  $100. 

6.  Bought  of  Walter  Hess  on  account  $850. 

7.  Cash  sales  per  cash  register  $317.92. 

9.    Bought   merchandise   from   Smalley   Bros,   on   60-day 

note  $258. 
10.    Sold  merchandise  to  Adam  Morton  for  his  60-day  note 
$118.50. 


330 


MISCELLANEOUS  ACCOUNTING  TOPICS 


12.  Paid  Walter  Hess  $500  on  account. 

13.  Received  Alfred  Carpenter's  check  for  $300  on  account. 

14.  Cash  sales  for  week  $314.30. 

15.  Gave  Smalley  Bros,  a  check  in  payment  of  60-day  note 

of  9th,  less  discount  at  6%. 

16.  Paid  Arthur  Harrison  cash  $436.20  for  merchandise. 

18.  Bought  merchandise  of  Lewis  Sadler  on  30-day  note 

$375.09. 

19.  Sold  merchandise  to  John  Kingsley  for  cash  $641.84. 

20.  Cash  sales  $385.37. 

23.    Bought  coal   for  store   use  $28.50,   stamps  $10,   and 
petty  cash  expenses  $20. 


3.     Illustrative  Forms 


CASH 

Date 

L.F. 

Cash 

Sales 
Cash 

Receivable 
Accounts 

General 

1918 
Oct.      1 
7 
13 
14 
15 
19 
20 
24 
27 
29 
30 

Alfred  Carpenter 

$  8,500.00 
347.92 
300.00 
314.30 
2.32 
641.84 
385.37 
148.50 
427.51 
500.00 
278.19 

$ 

347.92 

314.30 

641.84 
385.37 

427.51 

278.19 

$ 

300.00 

500.00 

$8,500.00 

2.32 

148.50 

Discount  on  Notes  Payable. . 
Notes  Receivable 

$11,845.95 

$2,395.13 

$800.00 

$8,650.82 

$11,845.95 

Form  13.    Cash  Book,  showing 


SUBSIDIARY  BOOKS  ILLUSTRATED 


331 


24.  Received   check   from  Adam   Morton   for  his   60-day 

note  of  the  10th,  less  discount. 

25.  Sold    Henry    Fox    bill    of    merchandise    on    account 

$841.30. 

26.  Paid  Andrew  Maxwell  $1,000  on  account. 

27.  Cash  sales  $427.51. 

28.  Sold  Anson  Dix  on  his  30-day  note  $832.40. 

29.  Received  $500  from  Henry  Fox  to  apply  on  account. 

30.  Paid  $58.10  for  freight  and  drayage;  $60  for  clerk's 

and  $70  for  bookkeeper's  salary;  $8.10  for  gas  bill; 
$14.20  for  sundry  expenses.  Cash  sales  to  date 
$278.19. 


BOOK 


Date 


L.F. 


Cash 


Cash 
Purchases 


Accounts 
Payable 


General 


1918 

Oct.     1 

1 

1 

2 

3 

12 

15 

16 

23 

24 

26 

30 


Rent 

Furniture  and  Fixtures 

Supplies    

Advertising   

Purchases   

Walter  Hess  

Notes  Payable 

Purchases   

Expense    

Discount  on  Notes  Rec. 

Andrew  Maxwell 

Freight   

Salaries 

Expense    

Payments   

Balance  Oct.  31 

Total  per  contra. . . . 


75.00 
527.31 

24.00 

40.00 
121.08 
500.00 
258.00 
436.20 

58.50 

1.14 

1,000.00 

58.10 
130.00 

22.30 


$  3,251.63 
8,594.32 


$11,845.95 


121.08 


500.00 


436.20 


1,000.00 


$      75.00 

527.31 

24.00 

40.00 


258.00 

58.50 
1.14 

58.10 

130.00 

22.30 


$557.28 


$1,500.00 


$1,194.35 


Ledger  Controlling  Entries 


332 


MISCELLANEOUS  ACCOUNTING  TOPICS 


1 

GENERAL  JOURNAL 

October,  1918 

Accounts 
Payable 

General 

|l.f. 

L.F. 

General 

Accounts 
Receivable 

—9— 

$258.00 

$    148.50 

To  Notes  Payable. . . 
—10— 

To  Adam  Morton. . . . 
—18— 

$    258.00 

$148.50 

375.09 

832.40 

To  Notes  Payable. . . 
—28— 

To  Anson  Dix 

375.09 

832.40 

$633.09 

$980.90 

—31— 

633.09 

to    Accounts  Receiv- 

980.90 

$1,613.99 

$1,613.99 

l 

Form  14.    General  Journal 


SALES     BOOK 

L.F. 

1918 
Oct.     5 
10 
25 

28 

17 

18 
If) 
21 

Adam  Morton 

$   400.00 
148.50 

Henry  Fox 

841.30 
832.40 

$2,222.20 

Anson  Dix   

Accounts  Receivable 

$2,222.20 

! 

Form  15.   Sales  Book 


SUBSIDIARY  BOOKS  ILLUSTRATED 


PURCHASE     BOOK 

L.F. 

f 

1918 
Oct.     1 

6 
9 

18 

3 

7 
8 
9 

Andrew  Maxwell  

Walter  Hess  

$3,878.95 
850.00 
258.00 
375.09 

$5,362.04 

Smalley  Bros 

To  Accounts  Payable. .      j 

$5,362.04 

Form  16.    Purchase  Book 


4.     Comments  on  Entries  of  Transactions 

October  1-7.  The  transactions  between  the  dates  of 
October  1  and  October  7  are  of  a  simple  character  and 
require  no  comment.  If  the  entry  of  any  one  of  them  is 
not  thoroughly  understood,  reference  should  be  had  to 
preceding  chapters  in  which  the  various  books  of  original 
entry  are  explained  in  detail. 

9-10.  A  purchase  or  a  sale  which  is  immediately  set- 
tled by  a  note  payable  or  a  note  receivable  is  sometimes 
entered  only  in  the  Purchases  and  Notes  Payable,  or 
Sales  and  Notes  Receivable  accounts,  as  the  case  may 
be.  This,  however,  is  not  the  most  approved  practice. 
It  is  preferable  to  record  the  purchase  and  the  sale  in 
the  individual  or  personal  accounts  with  the  creditor  and 
the  customer  and  then  to  offset  the  entries  in  those  ac- 
counts with  a  credit  for  the  note  receivable  and  a  debit 
for  the  note  payable,  the  compensating  or  offsetting 
entry  for  the  notes  being  made  in  the  Notes  Receivable 
and  Notes  Payable  accounts.  In  this  way  the  entire  pur- 
chases or  sales,  or,  in  other  words,  the  entire  busim  gfl 


334         MISCELLANEOUS  ACCOUNTING  TOPICS 

done  with  the  customer  and  the  creditor,  is  recorded  in 
the  individual's  account.  It  is  convenient  to  follow  this 
latter  procedure  because  it  enables  one  to  determine 
readily  the  total  purchases  from  each  creditor  and  the 
total  sales  to  each  customer  during  any  specified  period, 
regardless  of  the  manner  of  settlement  of  the  account. 
Such  information  is  often  of  value  when  it  is  desired  to 
fix  terms  of  credit  with  a  customer  or  to  seek  such  terms 
from  a  creditor.  When  purchases  have  been  many  and 
large  in  volume,  and  when  payments  have  been  made 
with  promptness,  more  liberal  terms  of  credit  on  future 
business  may  often  be  secured  than  those  originally 
granted. 

12-14.  The  entries  for  the  transactions  on  these 
dates  require  no  comment. 

15.  By  this  transaction  a  note  payable  is  settled  be- 
fore its  maturity.  This  would  necessarily  require  the 
consent  of  the  payee  unless  the  note  read  "on  or  before" 
its  maturity  date.  As  it  is  paid  before  its  maturity  the 
face  value  need  not  be  paid.  Interest  or  discount  on 
the  note  for  the  unexpired  time  is  deducted  and  a  check 
is  given  for  the  net  amount.  In  order  to  facilitate  the 
posting  of  the  gross  amount  or  the  face  value  of  the  note 
to  the  debit  of  Notes  Payable,  the  entry  in  the  cash  book 
shows  an  apparent  payment  of  the  face  value  of  the 
note  offset  by  an  apparent  receipt  of  the  amount  of  the 
discount.  If  Form  13  is  used,  either  this  procedure  is 
required  or  the  entry  of  the  discount  may  be  made  in 
red  ink  on  the  credit  side  of  the  cash  book.  Or,  a  jour- 
nal entry  for  the  discount  could  be  made  and  only 
the  check  entered  in  the  cash  book,  but  this  would 
necessitate   two   postings   to   Notes   Payable.     While 


SUBSIDIARY  BOOKS  ILLUSTRATED  335 

the  above  method  of  recording  the  discount  inflates  the 
amounts  of  cash  receipts  and  cash  payments,  it  does  not 
affect  the  correctness  of  the  cash  balance. 

16-30.  The  only  transaction  under  the  dates  speci- 
fied which  requires  comment  is  that  of  the  24th,  whereby 
a  check  was  received  from  the  maker  of  a  note  receiv- 
able settling  the  note  prior  to  its  maturity.  The  trans- 
action is  recorded  similarly  to  that  of  the  15th  except, 
of  course,  that  the  entries  are  reversed. 

5.      Preparation  of  Statements 

The  trial  balance,  the  statement  of  profit  and  loss, 
and  the  balance  sheet  presented  below  provide  a  simple 
exercise  in  the  preparation  of  the  customary  financial 
statements  which,  after  all,  is  the  ultimate  object  of 
bookkeeping.  The  first  step  in  the  preparation  of  such 
statements  is  to  take  a  trial  balance.  The  next  step  is 
the  preparation  of  closing  entries  which  are  not  shown 
in  this  chapter  because  of  their  simplicity  and  because 
the  method  of  preparing  them  has  been  fully  explained 
in  Chapter  VIII.  Before  the  closing  entries  can  be  pre- 
pared it  is  necessary  to  take  inventories,  and  in  this  illus- 
trative case  the  inventories  are  assumed  to  be  as  follows: 

Merchandise $2,186.72 

Books  and  Stationery 20.00 

Furniture  and  Fixtures 500.00 

Unused  Advertising 20.00 

The  profit  and  loss  account  is  in  the  running  or  state- 
ment form,  which  is  generally  preferred  to  the  double- 
entry  or  account  form,  as  being  more  easily  understood 
by  persons  not  familiar  with  bookkeeping  forms  and 
terminology. 


336         MISCELLANEOUS  ACCOUNTING  TOPICS 
TRIAL  BALANCE 

George  Clark $  8,500.00 

Furniture  and  Fixtures  ($500) $  527.31 

Cash    8,594.32 

Accounts  Receivable -141.30 

Notes  Receivable 832.40 

Accounts   Payable 3,228.95 

Notes  Payable 375.09 

Purchases  ($2,186.72) 5,919.32 

Freight   58.10 

Sales 4,617.33 

Discount 1.18 

Office  Supplies  ($20) 24.00 

Rent    75.00 

Salaries    1 30.00 

Advertising    ($20) 40.00 

Expense 80.80 

$16,722.55     $16,722.55 


STATEMENT  OF  PROFIT  AND  LOSS 
Sales $4,61 7.33 

Cost  of  Goods  Sold: 

Purchases   $5,919.32 

Freight 58.10 

Total $5,977.42 

Inventory,  October  31.  1918 2,186.72       3,790.70 

Gross   Profit $    826.63 

Expense: 

Advertising    $  20.00 

Salaries    130.00 

Rent    75.00 

General  Expense 80.80 


SUBSIDIARY  BOOKS  ILLUSTRATED 


337 


Office  Supplies 4.00 

Depreciation  on  Furniture  and  Fixtures. .  .  .         27.31 


Total $337.1 1 

Discount  Earned 1.18  335.93 


Net  Profit $    490.70 

BALANCE  SHEET 


Assets 

Cash $  8,594,32 

Accounts    Receivable.., 

Notes   Receivable , 

Merchandise    

Supplies    

Advertising    

Furniture  and  Fixtures 


Liabilities 

Accounts  Payable $  3,228.95 

Notes    Payable 375.09 


441.30 
832.40 
2,186.72  $  3,604.04 

20.00    ;    George  Clark  : 
20.00       Investment    ...$8,500.00 
500.00    '    Net   Profit 490.70  8,990.70 


$12,594.74 


$12,594.74. 


CHAPTER    XXXI 

PARTNERSHIP  ACCOUNTING— OPENING 
AND    CURRENT    ENTRIES 

1.  Special  Features  of  Partnership  Accounting 

The  accounting  for  a  partnership  differs  from  that 
for  a  sole  proprietorship  only  in  the  opening  entry,  in 
the  distribution  of  profits  and  losses,  and  in  the  liquida- 
tion entry  when  the  partnership  is  dissolved.  These 
differences  are  not  due  to  any  distinctive  method  of 
conducting  a  partnership  business,  but  solely  to  the 
fact  that  in  a  partnership  there  is  more  than  one  pro- 
prietor. The  present  chapter  discusses  the  opening 
entry  and  the  distribution  of  partnership  profit  and 
loss,  and  in  Chapter  XXXII  there  is  an  explanation  of 
the  accounting  procedure  upon  the  dissolution  of  a  part- 
nership. 

2.  Necessity  for  Separate  Capital  Accounts 

Where  there  is  only  one  proprietor,  the  business  is 
accountable  to  him  for  the  entire  excess  of  assets  over 
liabilities.  Where  there  is  more  than  one  proprietor, 
as  in  a  partnership,  the  capital  must  in  some  way  be 
apportioned  and  a  separate  capital  account  for  each 
partner  must  be  kept  to  indicate  his  share.  Such  an 
account  represents  the  amount  which  would  be  paid  to 
him  in  cash  or  property  if  the  assets  of  the  firm  realized 
their  book  value  when  the  business  was  dissolved  and 
all  creditors  paid. 


PARTNERSHIP  ACCOUNTING        339 

A  partner's  capital  account  is  opened  when  he  in- 
vests any  assets  in  the  firm.  If  the  firm  assumes  liabil- 
ities in  connection  with  assets  which  an  incoming  part- 
ner turns  over  to  it,  his  capital  account  should  indicate 
the  net  amount  of  capital  invested — either  by  showing 
the  assets  on  one  side  and  the  liabilities  on  the  other,  or 
by  showing  only  the  net  amount.  It  follows  from  this 
that  the  capital  contributed  must  be  definitely  agreed 
upon.  If  an  asset  other  than  cash  forms  part  of  the  capi- 
tal it  must  be  definitely  appraised,  because  it  may  not 
in  the  future  realize  the  book  value  at  which  it  is  cred- 
ited to  the  partner's  capital.  When  once  an  asset  is 
valued,  any  subsequent  loss  is  a  firm  loss  and  any  sub- 
sequent profit  is  a  firm  profit.  If  the  value  of  such  an 
asset  be  not  definitely  agreed  upon,  misunderstanding 
may  later  arise  as  to  whether  or  not  such  loss  or  profit 
should  be  considered  as  an  adjustment  of  the  capital 
account  of  the  partner  contributing  the  asset. 

3.    Usual  Opening  Entry 

In  a  simple  and  uncomplicated  case,  the  opening 
entry  is  not  difficult  to  prepare.  In  every  case  it  is  ad- 
visable to  make  this  entry  in  the  general  journal,  and 
to  include  in  it  a  brief  statement  of  the  formation  of 
the  partnership,  the  names  of  the  partners,  and  such 
other  information  concerning  their  contract  as  may  not 
be  too  confidential  for  display  upon  the  office  books. 

The  following  example  of  an  opening  entry  will 
serve  as  a  type  for  simple  cases. 

May  1,  1919 
The  firm  of  Brown  &  Peacock  has  this  day  been 
formed  to  conduct  the  business  of  general  retailing 


340         MISCELLANEOUS  ACCOUNTING  TOPICS 

for  a  period  of  five  years  from  date.     The  mem 
bers  of  the  firm  are  H.  P.  Brown  and  James  L. 
Peacock,    who    are    to    share    profits    and    losses 
equally  and  who  contributed  assets  and  for  whom 
the  firm  assumed  liabilities  as  hereunder  noted. 

Cash    $    604.17 

Notes   Receivable    200.00 

Curtis  &  Guild 17.42 

Cohn  &  Brother 906.00 

Hopkins  &  Giles 314.89 

Merchandise  Inventory 1,000.00 

Furniture  and  Fixtures 602.00 

To  H.  P.  Brown,  Capital $3,644.48 

Assets  contributed  to  the  firm  by  H.  P. 
Brown. 

H.  P.  Brown,  Capital 315.00 

To  Acme  Manufacturing  Co 215.00 

"    Whitcomb  &  Converse 100.00 

Liabilities  of  H.  P.  Brown  assumed  by 
the  firm. 

Cash 318.97 

Sharp  &  Burton 199.83 

Saddler  &  Lee 32.46 

Gilchrist  &  Hitchcock 481.00 

Merchandise  Inventory 700.00 

Furniture  and  Fixtures 900.00 

To  James  L.  Peacock,  Capital 2,632.26 

Assets  contributed  to  the  firm  by  James 
L.  Peacock,  no  liabilities  being  as- 
sumed on  his  account. 

It  will  be  noticed  from  the  journal  entry  that  Mr. 
Brown's  account  will  show  the  assets  on  one  side  and 
the  liabilities  on  the  other.  The  same  result  could  be 
obtained  by  making  what  is  known  as  a  compound  jour- 


PARTNERSHIP    ACCOUNTING  341 

nal  entry  in  which  only  the  net  amount  of  $3,329.48 
would  be  credited  to  his  capital  account.  There  is  a 
slight  advantage  in  showing  both  the  assets  and  the  lia- 
bilities, in  that  it  would  not  be  necessary  later  to  refer 
to  the  journal  in  order  to  ascertain  those  facts. 

The  inclusion  of  cash  in  the  above  journal  entries  re- 
quires a  word  of  comment.  These  balances  of  cash  con- 
tributed to  the  firm  appear  also  in  the  cash  book  and 
it  is  evident  that  they  should  not  be  entered  twice  in 
Cash  account  or  in  the  capital  account.  Yet  it  is  de- 
sirable that  these  items  be  included  in  the  journal  entry 
in  order  to  show  the  complete  contribution  of  each  part- 
ner, and  they  must  appear  in  the  cash  book  because  they 
constitute  cash  receipts  by  the  firm.  The  way  to  avoid 
duplication  of  posting  is  to  indicate  in  the  journal  that 
Cash  account  is  not  to  be  debited,  and  to  indicate  on 
the  cash  book  that  capital  account  is  not  to  be  credited. 
In  this  way  Cash  account  will  be  debited  from  the  cash 
book,  and  the  capital  account  will  be  credited  from  the 
journal. 

4.     Opening   Entry  When  Capital   Is   Indefinite 

A  simple  example  of  the  contributions  of  partner- 
ship assets  upon  which  no  specific  value  is  placed,  is 
the  contribution  of  accounts  receivable  under  an  agree- 
ment that  the  partner's  capital  account  is  to  be  credited 
only  with  the  amounts  actually  collected  on  such  ac- 
counts. To  carry  out  this  agreement  the  amount  of 
this  estimated  contribution  should  be  credited  to  a  sus- 
pense account  which  may  be  entitled  " 's  Capital 

Adjustment."  At  the  end  of  each  month  the  amount 
of  the  total  cash  collections  on  these  accounts,  as  shown 


342         MISCELLANEOUS  ACCOUNTING  TOPICS 

by  the  cash  book,  should  be  journalized  in  the  follow- 
ing manner: 

's  Capital  Adj  ustment $ 

To 's  Capital $ 


In  this  way  the  partner's  capital  account  will  be  cred- 
ited only  with  the  amounts  actually  collected.  If  any 
of  them  eventually  prove  to  be  uncollectible,  they 
should  be  written  off  by  the  following  entry: 

's  Capital  Adjustment $ 

To  Accounts  Receivable $ 


5.    Opening  Entry  Where  No  Capital  Is  Contributed 

Sometimes  a  partner  is  admitted  under  an  agree- 
ment to  give  him  merely  an  interest  in  the  profits  of 
the  firm.  This  is  frequently  the  case  when  an  employee 
is  made  a  partner  and  given  a  share  of  the  profits  in 
lieu  of  salary.  When  such  an  incoming  partner  con- 
tributes no  assets,  and  when  the  firm  assumes  no  liabil- 
ities for  him,  no  capital  account  is  needed  to  represent 
his  interest.  Since  such  an  account  shows  the  share  of 
the  capital  which  each  partner  owns,  it  is  evident  that 
if  nothing  is  owned  no  capital  account  is  required.  In 
this  example,  the  incoming  partner  would  have  a  capital 
account  only  if  profits  were  earned  and  he  became  en- 
titled to  a  share  of  them. 

An  agreement  of  this  sort  should  specifically  state 
whether  or  not  the  incoming  partner  is  to  be  charged 
with  a  share  of  possible  losses.  Losses  are  usually  not 
contemplated  but  they  not  infrequently  occur.  Unless 
the  agreement  specifically  provides  that  the  new  part- 
ner is  to  be  charged  with  a  portion  of  the  losses,  if  any, 


PARTNERSHIP    ACCOUNTING  343 

considerable  ill-feeling  may  result  when  a  loss  has  to 
be  distributed.  Whether  or  not  a  person  who  is  to  share 
only  in  the  profits  must  also  bear  his  portion  of  losses 
and  whether  or  not  he  becomes  a  full  partner,  are  ques- 
tions of  law  which  are  quite  beyond  the  scope  of  this 
volume. 

6.    Division  of  Profits  and  Losses 

Since  men  may  contract  to  do  anything  not  pro- 
hibited by  law,  partners  may  agree  to  divide  profits 
in  any  way  desired.  The  most  general  modes  of  divi- 
sion are  noted  in  the  following  section.  It  is  not  always 
realized,  however,  that  in  the  absence  of  a  definite  agree- 
ment profits  and  losses  must  be  shared  equally.  This 
rule  of  law  is  applied  even  though  one  of  two  partners 
may  devote  his  entire  time  to  the  business  and  contribute 
all  the  capital,  while  the  other  partner  gives  neither 
time  nor  capital — the  reason  being  that  due  to  the  in- 
timacy of  the  partnership  relation  the  law  cannot  de- 
termine the  relative  values  of  the  partners  to  a  given 
business  enterprise.  A  partner  who  contributes  no 
capital  may  contribute  valuable  services.  Again, 
though  contributing  neither  capital  nor  services,  he  may 
be  the  means  of  securing  business  or  business  advantages 
for  the  firm. 

So  many  questions  would  be  involved  in  an  ef- 
fort to  determine  how  profits  should  be  divided  that  the 
law  simply  states  that,  in  the  absence  of  agreement, 
profits  and  losses  are  to  be  shared  equally.  This  means 
their  division  into  as  many  parts  or  shares  as  there  are 
partners,  regardless  of  the  balances  in  the  partners' 
capital  accounts. 


344         MISCELLANEOUS  ACCOUNTING  TOPICS 
7.    Bases  of  Division 

A  common  method  of  apportioning  profits  or  losses 
is  by  fixed  percentages.  For  example,  one  partner  may 
be  allowed  three-fifths  of  the  profit  and  the  other  two- 
fifths;  or,  in  a  firm  of  three,  one  may  be  given  50%, 
another  30%,  and  the  third  20%.  The  division  of  profits 
and  losses  on  such  a  basis  presents  no  accounting  diffi- 
culties. 

Another  basis  of  division  is  that  of  capital  invested. 
This  should  be  clearly  defined  in  the  partnership  con- 
tract in  order  to  avoid  misinterpretation.  Where  the 
capital  of  each  partner  remains  fixed,  no  difficulty,  of 
course,  presents  itself ;  but  if  each  partner's  capital  fluc- 
tuates, either  by  the  addition  of  profits  or  the  deduction 
of  drawings  or  losses,  at  the  end  of  the  year  a  question 
arises  as  to  whether  this  division  is  to  be  based  on  the 
capital  at  the  beginning  of  the  year  or  the  capital  as 
adjusted  at  the  close.  A  question  of  some  difficulty 
arises  if  the  distribution  of  profits  is  to  be  based  on  the 
capital  at  the  close  of  the  year  as  adjusted  by  the  prof- 
its, because  the  distribution  must  then  be  made  before 
the  basis  for  the  division  of  profits  is  determined.  Gen- 
erally an  agreement  of  this  kind  should  be  made  only 
when  the  capital  remains  fixed,  all  the  profits  being 
withdrawn  each  year.  Under  such  circumstances  the 
division  of  profits  or  losses  presents  no  difficulty. 

Where  the  capital  accounts  fluctuate,  a  fair  method 
is  to  base  the  distribution  on  capital,  considering  also 
the  length  of  time  during  which  it  has  been  invested. 
It  is  evident  that  one  partner  who  has  had  an  invest- 
ment of  $50,000  for  twelve  months  should  not  share 
equally  with  another  who  has  had  an  investment  of  the 


PARTNERSHIP    ACCOUNTING  345 

same  amount  for  only  nine  months.  As  the  division  of 
profits  and  losses  upon  this  basis  involves  some  compli- 
cations, the  following  section  will  describe  it  in  detail. 

8.     Division  on  Basis  of  Capital  and   Time 

The  first  step  in  distributing  profits  and  losses  under 
this  method  is  to  reduce  the  capital  accounts  of  all  the 
partners  to  a  common  denominator  so  as  to  furnish  a 
basis  for  comparison.  The  best  common  denominator 
for  this  purpose  is  in  each  case  the  amount  which  for 
one  month  would  equal  the  amounts  actually  invested 
during  the  actual  time  of  investment.  The  basis  upon 
which  the  equivalent  amounts  are  thus  determined  is 
really  that  of  their  interest  value.  For  example,  $100 
invested  for  two  months  would  be  equivalent  to  $200 
invested  for  one  month.  The  following  illustrative  case 
will  make  this  process  clear: 

Partner    A    invested    the    following    amounts: 

January    1,   1918  $2,000 

July  Ij  1918  8,000 

Partner  A   withdrew  the   following  amounts: 

March   1,  1918       $1,000 

October  1,  1918  2,000 
Partner    B    invested    the    following    amounts: 

January    1,    1918   $3,000 

October  1,  1918  2,000 
Partner  B   withdrew   the   following  amounts: 

March  1,  1918        $1,000 

The  problem  now  presented  is  to  reduce  the  invest- 
ments of  all  partners  to  some  common  denominator  or 
basis  so  that  they  can  be  compared.  As  has  been  stated, 
the  most  convenient  method  is  to  ascertain  for  each  part- 
ner the  amount  of  capital  which  if  invested  for  one 


346         MISCELLANEOUS  ACCOUNTING  TOPICS 

month  would  be  equivalent  to  the  actual  capital  during 
the  time  that  it  remained  in  the  business. 

Partner  A  had  $2,000  in  the  business  for  two  months 
when  he  withdrew  $1,000,  leaving  his  capital  for  the 
next  four  months  $1,000.  On  July  1,  1918  he  contrib- 
uted $3,000,  raising  his  capital  to  $4,000,  at  which  sum 
it  remained  for  three  months.  On  October  1,  he  with- 
drew $2,000  which  reduced  his  capital  to  $2,000,  at 
which  amount  it  remained  for  three  months.  The  prob- 
lem is  to  ascertain  what  amount  of  capital  invested  for 
one  month  would  be  equivalent  in  interest  value  to  these 
varying  amounts  left  in  the  business  for  these  varying 
periods  of  time.  The  same  calculation  for  B's  capital 
will  furnish  a  basis  for  comparison. 

The  following  calculations  show  how  the  equivalent 
amount  for  each  partner  in  the  hypothetical  case  stated 
above  is  determined : 

A's  Capital 

Balance  of  $2,000  for  2  mos.,  equivalent  to  $  4,000  for  one  month 

"      1,000    "  4    "  "  "        4,000    "     " 

"     4,000    "  3    "  "  "      12,000    "     " 

"     2,000    "  3    "  "  '*        6,000    "     " 


Actual  capital  during  12    "  "  "  $26,000 


B's  Capital 

Balance  of  $3,000  for     2  mos.,  equivalent  to  $  6,000  for  one  month 
"         "     2,000    "       7    "  "  "      14,000    "     " 

"     4,000    "       3    "  "  "      12,000    "     " 


Actual  capital  during  12    "  "  "  $32,000 


PARTNERSHIP    ACCOUNTING  347 

In  each  case  there  has  been  determined  the  amount 
which  for  one  month  would  be  equivalent  to  the  actual 
capital  left  in  the  business  during  the  entire  year.  From 
the  ready  means  of  comparison  thus  afforded,  it  will  be 
seen  that  the  two  investments  are  of  the  relative  value  of 
26  and  32.  A  is  entitled  to  26/58  or  13/29,  and  B  to 
32/58  or  16/29  of  the  profits. 

There  are  two  ways  of  testing  the  foregoing  calcula- 
tions. The  last  balance  used  must  agree  with  the  bal- 
ance in  the  capital  account  at  the  end  of  the  year  and 
the  total  number  of  months  must  equal  twelve.  No  fur- 
ther calculating  is  needed  to  arrive  at  a  basis  for  division 
of  profits  or  losses;  but,  if  desired,  the  average  capital 
of  each  partner  can  be  shown  by  dividing  the  total  of 
the  equivalents  by  12.  The  average  for  A  is  $2,166.67, 
and  for  B  $2,666.67. 

9.    Compensation  for  Unequal  Capital 

When  partners  invest  capital  in  unequal  amounts, 
their  contract  sometimes  provides  that  interest  shall  be 
paid  on  the  amount  of  capital  contributed.  This  interest, 
of  course,  is  paid  by  the  firm  itself.  The  tendency  of 
such  interest  adjustments,  as  explained  in  the  next  sec- 
tion, is  to  compensate  the  partner  with  the  largest  in- 
vestment for  the  excess  of  his  contribution.  Another 
method  of  compensation  for  either  unequal  capital  or 
additional  service,  is  to  allow  a  partner  a  so-called  salary 
which  gives  him  compensation  in  excess  of  what  he 
otherwise  would  have  received.  Both  of  these  expedients 
are  discussed  in  following  sections.  Because  of  their  im- 
portance, the  economic  theories  underlying  them  and  the 
procedure  to  apply  them  should  be  studied. 


348         MISCELLANEOUS  ACCOUNTING  TOPICS 
10.    Interest  on  Capital 

From  the  economist's  point  of  view  the  return  from 
a  business  should  be  analyzed  into  three  elements.  The 
first  is  interest  on  capital  invested,  calculated  at  an  in- 
vestment rate;  the  second  is  in  the  nature  of  salary  for 
services  rendered;  and  the  remainder  of  the  return,  if 
any,  is  regarded  as  profit  due  to  venturing  capital  in  the 
business. 

From  the  accountant's  point  of  view  the  entire  re- 
turn which  a  proprietor  secures,  whether  he  be  in  busi- 
ness alone  or  in  a  partnership,  constitutes  his  profit ;  any 
division  of  this  amount  on  an  assumed  interest  basis  or 
an  arbitrary  salary  scheme  is  a  matter  which  in  the  judg- 
ment of  the  accountant  does  not  make  the  return  any- 
thing except  profit. 

The  reason  for  the  accounting  viewpoint  is  that  in- 
terest on  capital  and  also  salaries  paid  to  partners  (as 
explained  in  the  next  section)  do  not  in  any  way  reduce 
the  total  capital  invested  in  the  business.  Considered 
collectively,  the  partners  are  neither  richer  nor  poorer 
after  such  adjustments  have  been  made,  although  the 
interests  of  individual  partners  are  altered.  Thus  in- 
terest on  capital  and  salaries  paid  to  partners  are  not 
actual  expenses,  for  the  reason  that  no  one  outside  the 
business  profits  thereby;  that  is  to  say,  the  total  capital 
of  all  partners  is  neither  increased  nor  diminished. 

Another  perplexing  question  which  sometimes  arises 
in  connection  with  interest,  if  the  partnership  agreement 
provides  for  interest  on  capital,  is  whether  or  not  interest 
may  be  charged  also  on  drawings.  The  law  does  not 
permit  such  a  charge — nor  is  it  a  logical  consequence  of 
allowing  it  on  capital.    There  is  a  fundamental  differ- 


PARTNERSHIP    ACCOUNTING  349 

ence.  Each  partner  has  access  to  the  firm  books  and  the 
law  assumes  that  he  has  a  knowledge  of  their  contents 
and  that  no  money  can  be  withdrawn  without  knowl- 
edge, actual  or  implied,  on  the  part  of  each  partner. 
Therefore,  if  one  is  permitted  to  withdraw  cash  on  ac- 
count of  his  share  of  profits  to  be  later  determined,  it 
would  be  unfair  to  charge  him  with  interest  thereon  un- 
less he  has  agreed  to  pay  it ;  had  he  known  that  interest 
was  to  be  charged  he  could  have  refrained  from  making 
the  drawings.  Consequently,  without  a  definite  under- 
standing to  that  effect,  interest  must  not  be  charged  on 
drawings  even  though  it  may  be  credited  on  capital. 

1 1 .      Bookkeeping  for  Interest  on  Capital 

The  bookkeeping  of  interest  on  capital  requires 
merely  that  each  partner's  capital  account  be  credited 
with  the  interest  at  the  agreed  rate  and  that  some  off- 
setting account  be  debited.  It  is  not  good  practice  to 
debit  an  Interest  account  which  contains  interest  paid 
to  outsiders,  because  the  latter  constitutes  an  actual  ex- 
pense of  the  firm,  whereas  interest  on  capital  is  not  an 
expense.  The  best  practice  is  to  debit  such  interest 
either  to  the  Profit  and  Loss  account  or  to  a  special  ac- 
count containing  no  other  entries. 

That  the  effect  of  crediting  interest  on  partners' 
capital  is  merely  to  adjust  their  capital  accounts  is 
shown  by  the  following  example:  If  A  and  B  are 
partners,  A's  investment  being  $10,000  and  B's  $5,000, 
and  they  are  to  share  profits  and  losses  equally,  interest 
at  6%  on  the  capital  of  each  will  give  A  $600  and  B 
$300.  The  total  of  the  $900  so  credited  as  interest  will 
be  distributed  equally  between  the  two,  which  means  that 


350         MISCELLANEOUS  ACCOUNTING  TOPICS 

A  will  be  charged  with  $450  and  B  with  $450.  The  net 
result  of  this  is  that  A's  capital  has  been  increased  by 
$150  and  B's  has  been  decreased  by  the  same  amount. 

It  follows  from  this  that  if  profits  and  losses  were 
to  be  shared  in  the  ratio  of  capital  accounts,  no  effect  is 
secured  by  crediting  interest  on  capital  because  the  so- 
called  expense  of  the  interest  will  be  shared  in  the  same 
amounts  as  the  interest  is  credited.  In  the  example 
given  above,  A  is  debited  with  two-thirds  of  $900  or 
$600,  and  B  with  one-third  or  $300 — which  division 
exactly  offsets  the  credit  in  each  case. 

12.    Salaries  of  Partners 

So-called  salaries  of  partners  are  not  actual  salaries, 
although  for  statistical  purposes  they  may  be  so  treated 
in  the  accounts.  They  are  not  actual  expenses  because 
a  partner  entitled  to  a  salary  is  not  a  creditor  and  if 
there  are  no  profits  he  cannot  receive  a  salary.  In  case 
of  insolvency,  a  partner  to  whom  "salary"  is  due  does 
not  share  with  the  creditors.  The  bookkeeping  for  such 
salaries  should  be  merely  a  debit  to  a  special  salary  ac- 
count— so  that  the  amount  will  not  be  confused  with  the 
actual  salaries — and  a  credit  to  the  partner's  capital 
account. 

If  a  partnership  agreement  provides  a  percentage  of 
profits  as  salary,  care  should  be  taken  so  to  word  the  con- 
tract that  it  will  be  perfectly  clear  whether  or  not  the 
salary  is  itself  to  be  considered  an  expense  before  the 
determination  of  the  net  profits  on  which  the  percentage 
is  to  be  figured.  If,  for  example,  a  partner  is  allowed 
10%  of  the  net  profits  for  salary,  the  contract  should 
state  whether  or  not  this  10%  is  to  be  calculated  on  the 


PARTNERSHIP    ACCOUNTING  351 

net  profits  without  counting  the  salary.  In  that  case  the 
salary  would  be  10%  of  such  profits.  If,  on  the  other 
hand,  the  salary  is  itself  to  be  considered  an  expense, 
then  the  net  profits  before  such  salary  is  considered  con- 
stitute 110%  of  the  actual  net  profits.  Where  the  figures 
are  large  the  difference  in  interpretation  of  such  a  clause 
will  be  material. 


REVIEW  QUESTIONS 

1.  Compare  a  sole  proprietorship  with  a  partnership  with  regard  to 

special  features  of  partnership  accounting. 

2.  Compare  the  opening  entry  for  a  partnership  with  that  for  a 

sole  proprietorship. 

3.  What  should  go  into  the  opening  entries  of  a  partnership: 

(a)  Usually. 

(b)  When  capital  is  indefinite. 

(c)  When  no  capital  is  contributed. 

4.  In  the  case  of  a  partnership  how  would  you  dispose  of  the 

balance  of  the  Profit  and  Loss  account? 

5.  Compare  the  economic  with  the  accounting  point  of  view  with 

regard  to  interest  on  capital. 


CHAPTER   XXXII 

PARTNERSHIP  ACCOUNTING- 
DISSOLUTION    ENTRIES 

1 .  Introductory 

The  accounting  matters  in  connection  with  the  for- 
mation of  a  partnership  were  discussed  in  the  preceding 
chapter.  The  accounting  principles  concerning  partner- 
ship operation  are  no  different  from  those  found  in  the 
operation  of  a  sole  proprietorship  or  of  a  corporation. 
In  connection  with  dissolution,  however,  the  adjustment 
of  the  partners'  accounts  involves  certain  principles 
which  have  not  yet  been  presented.  This  chapter 
discusses  them. 

2.  Methods  of  Dissolution 

A  partnership  may  be  dissolved  voluntarily  by  agree- 
ment among  all  the  partners;  or  involuntarily  against 
the  consent  or  without  the  consent  of  one  or  more  of 
them.  Creditors  may  force  involuntary  dissolution  when 
a  partnership  is  insolvent.  The  procedure  in  that  event 
is  described  in  Chapters  XII  and  XIII. 

3.  Causes  for  Dissolution 

The  most  common  causes  for  dissolution  of  solvent 
partnerships  are  the  following: 

1.  Mutual  agreement  of  the  partners. 

2.  Expiration  of  term  of  agreement. 

3.  Death  of  a  partner. 

352 


PARTNERSHIP— DISSOLUTION    ENTRIES        353 

When  a  partnership  business  is  not  sufficiently  profit- 
able to  warrant  its  continuance,  or  when  there  is  serious 
disagreement  among  partners,  the  dissolution  is  usually 
by  mutual  agreement.  When  a  partnership  is  to  exist 
for  a  definite  period  of  time,  and  this  period  expires,  the 
partnership  will  be  dissolved.  Even  if  the  business  be 
continued,  a  new  partnership  will  actually  be  formed  or 
will  be  implied  by  law.  When  a  partner  dies,  the  part- 
nership is  dissolved  by  law  and  the  surviving  partner 
or  partners  must  settle  with  the  estate  of  the  deceased 
partner  for  the  latter's  interest. 

4.      Procedure  Upon  Dissolution 

When  a  firm  is  to  be  dissolved  the  first  step  is  to 
reduce  sufficient  assets  to  cash  in  order  to  pay  all 
creditors.  The  law  specifically  provides  that  creditors 
must  be  paid  first.  The  next  step  is  to  repay  any  loans 
which  partners  may  have  made  to  the  firm ;  not  contribu- 
tions of  capital  but  loans  which  it  was  agreed  were  to 
be  repaid  at  some  fixed  time.  Loans  usually  bear  inter- 
est and  such  interest  constitutes  an  actual  expense  of 
the  business  because  it  is  paid  in  money  to  the  partner 
as  if  he  were  an  outside  person.  After  liabilities  to 
creditors  and  partners'  loans  have  been  paid,  the  remain- 
ing assets  are  either  distributed  in  their  existing  form  or 
they  are  converted  into  cash  and  the  cash  is  distributed 
to  partners  on  their  capital  investments.  Any  assets  so 
taken  by  a  partner  must  be  charged  against  his  capital 
investment  at  their  book  value,  unless  an  agreement 
exists  to  turn  them  over  to  the  partner  at  some  other 
figure.  Several  perplexing  questions,  discussed  below, 
present  themselves  in  the  liquidation  of  a  partnership. 


354         MISCELLANEOUS  ACCOUNTING  TOPICS 
5.     Bookkeeping  Upon  Dissolution 

A  going  concern  carries  its  assets  at  cost,  with  proper 
provision  for  depreciation  in  connection  therewith. 
When,  however,  a  partnership,  for  example,  ceases  to 
be  a  going  concern  and  is  to  be  dissolved,  these  assets 
can  rarely  be  sold  at  their  book  values. 

The  best  bookkeeping  procedure  for  the  ordinary 
realization  of  assets  is  to  open  a  Realization  of  Assets 
account  in  the  ledger  and  to  debit  thereto  the  book  value 
of  all  assets  to  be  realized.  All  balances  in  reserve  for 
depreciation  accounts  should  be  credited  to  this  account 
because  they  represent  suspended  credits  properly  be- 
longing in  the  asset  accounts  for  which  depreciation 
has  been  provided.  Cash  does  not  need  to  be  debited  to 
such  an  account  because  it  is,  as  an  asset,  in  its  final  form 
and  hence  is  already  realized. 

As  cash  is  collected  for  assets  sold,  cash  account  is 
debited  and  realization  of  assets  account  is  credited.  Any 
assets  distributed  in  kind  should  be  debited  to  the  capi- 
tal account  of  the  partner  receiving  them  at  their  book 
value,  in  the  absence  of  an  agreement  to  take  them  at 
some  other  figure.  After  the  last  asset  has  been  sold 
or  distributed  to  partners,  the  Realization  of  Assets 
account  then  will  indicate  whether  or  not  all  assets  have 
produced  exactly  their  book  values.  If  more  has  been 
produced,  this  account  will  have  a  credit  balance ;  if  less, 
a  debit.  Such  profit  or  loss  should  be  distributed  to  the 
partners'  capital  accounts  like  any  other  profit  or  loss. 
The  Cash  account  then  remains  on  the  books  in  place 
of  the  former  asset  accounts.  The  final  step  in  the 
liquidation  is  to  distribute  the  cash  remaining  on  hand, 
so  that  all  accounts  will  be  closed  out. 


PARTNERSHIP— DISSOLUTION    ENTRIES         355 
6.      Illustrative  Problem 

The  basis  of  the  following  problem  is  an  actual,  liti- 
gated case.  Originally,  partner  A  invested  $5,000  and 
partner  B,  $10,000.  Both  these  amounts  remained  in 
the  firm  unaltered  by  additional  contributions  or  by 
withdrawals.  The  partnership  agreement  made  no  men- 
tion of  the  method  of  distributing  profits  and  losses.  The 
firm  dissolved  and  after  creditors  were  paid  $8,000  re- 
mained in  cash. 

A  dispute  arose  in  regard  to  the  division  of 
this  $8,000  between  A  and  B.  Since  the  contract  did 
not  specify  how  profits  and  losses  were  to  be  divided,  A 
maintained  that  the  $8,000  should  be  divided  equally. 
B,  on  the  other  hand,  insisted  that  the  division  should 
be  in  proportion  to  their  capital  account  balances;  B  to 
receive  2/3,  or  $5,333.33. 

Neither  contention  is  correct.  A  is  wrong  because 
the  $8,000  is  an  asset  and  not  a  profit  and  loss  item.  The 
division  of  profits  has  no  bearing  whatever  upon  the  dis- 
tribution of  assets.  B  is  not  correct  because  the  capital 
accounts  as  they  stand  do  not  represent  the  present  own- 
ership of  the  partners  in  the  remaining  assets. 

In  the  above  case  the  first  step  should  be  the  prepara- 
tion of  a  balance  sheet.  A  deficit  of  $7,000  is  revealed, 
since  the  only  asset  is  cash  of  $8,000  offset  by  capital 
accounts  of  $15,000.  This  deficit,  representing  a  loss, 
should  be  divided  equally  between  the  two  partners.  A's 
capital  is  reduced  thereby  to  $1,500,  and  B's  capital  to 
$6,500.  The  capital  accounts  as  adjusted  now  show  the 
ownership  of  each  partner  in  the  $8,000.  Its  distribu- 
tion, therefore,  would  be  $1,500  to  A  and  the  balance  of 
$6,500  to  B. 


356         MISCELLANEOUS  ACCOUNTING  TOPICS 

7.  Liquidating  Dividends 

The  payments  made  to  a  partner  upon  the  dissolu- 
tion of  a  firm  in  settlement  or  liquidation  of  his  capital 
are  known  as  liquidating  dividends.  The  term  dividend 
as  here  used  must  not  be  confused  with  that  of  corpora- 
tion dividends — which  are  distributions  of  profit. 

When  a  firm  dissolves,  it  is  usual  to  make  partial 
payments  from  time  to  time  as  cash  becomes  available 
for  this  purpose.  This  method  is  advisable  because  the 
accumulation  of  cash,  until  the  last  asset  has  been  rea- 
lized, serves  no  useful  purpose  and  deprives  the  partners 
of  the  use  of  money  to  which  they  are  entitled. 

A  danger  exists,  however,  in  making  partial  pay- 
ments or  partial  liquidating  dividends.  There  is  no 
means  of  knowing  precisely  how  much  each  partner  will 
finally  be  entitled  to  receive  until  the  liquidation  is  com- 
pleted. Hence,  when  partial  dividends  are  paid,  one 
partner  may  receive  more  than  he  will  ultimately  be 
entitled  to,  and  thus  he  will  become  indebted  to  the 
other  partners.  It  may  be  exceedingly  difficult,  if  not 
impossible,  for  these  others  to  secure  reimbursement 
from  him.  When  a  partnership  dissolves,  considerable 
ill  feeling  is  not  uncommon  and  it  might  be  necessary 
to  resort  to  litigation  if  a  partner  should  inadvertently 
be  overpaid.  Consequently  every  effort  must  be  made 
to  avoid  such  overpayment. 

8.  Avoiding  Overpayment  of  Partners 

Overpayments  of  partners  can  be  avoided  by  making 
the  first  payments  in  such  amounts  as  will  reduce  the 
partners'  capital  account  balances  to  the  profit  and  loss 
sharing  ratio. 


PARTNERSHIP— DISSOLUTION    ENTRIES        357 

Assume  that  A  and  B  are  partners,  sharing  profits 
and  losses  2/3  to  A  and  1/3  to  B.  At  the  time  of  disso- 
lution A's  capital  account  has  a  credit  of  $63,000,  and 
B's  capital  account  has  a  credit  of  $27,000.  Assume 
also  that  the  first  liquidating  dividend  is  $12,000.  After 
the  payment  of  this  dividend  the  assets  will  be  $78,000. 
Two-thirds  of  this  is  $52,000  and  one-third  is  $26,000. 
The  dividend  of  $12,000  should  be  so  divided  that  after 
its  payment  A's  capital  account  will  represent  two-thirds 
and  B's  capital  account  one-third  of  the  remaining  assets. 
Consequently  $11,000  should  be  paid  to  A,  thus  reducing 
his  capital  to  $52,000,  and  $1,000  to  B,  leaving  his  capital 
account  $26,000. 

Since  losses  on  realization  of  assets  must  be  charged 
two-thirds  to  A  and  one-third  to  B,  neither  capital 
account  should  be  so  reduced  that  it  will  not  be  sufficient 
to  meet  its  share  of  possible  losses  on  future  realization ; 
if  it  does  reach  this  point,  one  partner  will  become  in- 
debted to  the  other — a  situation  to  be  avoided.*  If  the 
two  capital  accounts  are  adjusted  at  the  time  of  the 
first  dividends  so  that  they  stand  in  the  profit  and  loss 
sharing  ratio,  any  subsequent  losses  and  any  subsequent 
dividends  may  be  divided  in  the  ratio  of  their  capital 
accounts  since  that  will  be  the  same  as  the  profit  and 
loss  sharing  ratio. 

To  assume  an  extreme  case,  suppose  that  the  remain- 
ing $78,000  of  assets  proved  totally  uncollectible.  If 
the  $12,000  dividend  had  been  divided  equally  between 
A  and  B,  A's  capital  would  have  been  reduced  to  $57,000 
and  B  to  $21,000.  The  loss  of  $78,000  apportioned  two- 
thirds  to  A  and  one-third  to  B  would  leave  B  indebted  to 
A  in  the  sum  of  $5,000.    If  the  $12,000  had  been  appor- 


358         MISCELLANEOUS  ACCOUNTING  TOPICS 

tioned  two-thirds  to  A  and  one-third  to  B,  A's  capital 
account  would  have  been  reduced  to  $55,000  and  B's  to 
$23,000.  In  that  case,  charging  the  loss  of  $78,000 
would  leave  B  indebted  to  A  to  the  extent  of  $3,000. 
If  the  entire  liquidating  dividend  had  been  given  to  B, 
his  capital  would  then  have  been  reduced  to  $15,000  and 
B  ultimately  would  have  become  a  debtor  to  A  to  the 
extent  of  $11,000. 

If  a  partner  objects  to  receiving  dividends  in  any 
ratio  except  that  of  the  capital  accounts,  although  such 
procedure  might  result  in  an  overpayment  to  him  be- 
cause of  its  difference  from  the  profit  and  loss  sharing 
ratio,  no  dividends  should  be  paid  until  the  final  realiza- 
tion has  taken  place.  As  this  is  an  inconvenient  arrange- 
ment, the  objecting  partner  will  usually  be  inclined  to 
accept  the  method  outlined  above. 

9.      Debit  Balance  Against  Partner 

A  debit  balance  in  a  partner's  capital  account  upon 
dissolution  signifies  that  he  is  indebted  to  the  other  part- 
ners. If  he  refuses  to  pay  such  indebtedness  and  if  there 
is  no  way  of  compelling  him  by  litigation  to  do  so,  his 
debit  balance  becomes  an  uncollectible  account  receiv- 
able. It  constitutes  a  loss  which  like  any  other  must 
be  written  off. 

If  there  are  three  or  more  partners,  a  complication 
arises  in  such  a  case  because  losses  must  be  borne  equally, 
or  in  some  other  ratio  fixed  by  agreement.  Here,  how- 
ever, the  loss  must  be  distributed  otherwise  because  one 
of  the  original  partners  is  in  default  and  cannot  be  made 
to  share  the  loss. 

Assume  that  A,  B,  and  C,  partners,  share  profits 


PARTNERSHIP— DISSOLUTION    ENTRIES         359 

and  losses  1/4,  1/4,  and  1/2  respectively.  Assume  that 
A  becomes  indebted  to  B  and  C  through  inadvertent 
overpayments  to  him  on  his  capital  account  and  that  this 
indebtedness  against  A  is  uncollectible.  The  loss  on  this 
uncollectible  account  must  be  divided  then  between  B 
and  C.  The  question  arises  as  to  the  proportions  in 
which  B  and  C  should  bear  this  loss.  Under  the  original 
agreement  B  bore  1/4  and  C  1/2  of  all  losses.  The  loss 
on  A's  account  cannot  be  divided  in  that  way  because  it 
will  leave  1/4  undistributed.  The  usual  method  of  distri- 
buting such  a  loss  is  to  consider  B's  portion  as  1/3  and 
C's  as  2/3,  since  their  profit-sharing  ratios  of  1/4  and  1/2 
respectively  bear  that  relation  to  each  other.  One-third 
of  the  loss  of  the  balance  due  from  A  thus  becomes 
chargeable  to  B  and  two-thirds  to  C.  It  might  be 
argued,  however,  that  this  loss  should  be  borne  equally 
by  B  and  C  because  they  had  no  agreement  covering 
this  situation  and  thus  it  would  fall  under  the  rule  of 
law  that  losses  are  divisible  equally  in  the  absence  of 
agreement. 

10.      Sale  of  Partnership  Business 

A  partnership  business,  like  any  other,  is  frequently 
sold  outright  to  a  new  proprietor  or  proprietors.  It  may 
be  sold,  for  example,  to  a  corporation  formed  by  the 
partners  themselves  but  which  nevertheless  is  an  inde- 
pendent business  organization.  To  whomever  the  busi- 
ness is  sold,  it  becomes  necessary  to  make  liquidating 
entries  in  the  partnership  books.  The  bookkeeping  pro- 
cedure in  connection  therewith  is  simple. 

An  account  should  be  opened  with,  the  vendee  in 
which  to  record  the  amount  for  which  the  business  is 


360         MISCELLANEOUS  ACCOUNTING  TOPICS 

being  sold.  If  sold  for  the  exact  amount  of  the  present 
partners'  capital,  then  the  vendee  is  debited  with  the 
assets  turned  over  to  him  and  credited  with  all  liabilities 
of  the  partnership  assumed  by  him.  The  offsetting 
entries  will,  of  course,  be  to  the  credit  of  the  asset  ac- 
counts and  to  the  debit  of  the  liability  accounts.  This 
will  leave  on  the  partnership  books  one  account  repre- 
senting the  amount  due  from  the  vendee  and  as  many 
capital  accounts  as  there  are  partners.  When  the  vendee 
pays  for  the  business,  his  account  should  be  credited  and 
the  capital  accounts  debited,  the  actual  distribution  of 
the  cash  received  being  to  the  partners  in  .the  amounts 
called  for  by  their  respective  capital  accounts. 

If  the  business  be  sold  for  a  round  sum  which  is  in 
excess  of  the  combined  capital  of  all  the  partners,  a 
slightly  different  procedure  is  required.  A  Realization 
and  Liquidation  account  should  be  opened  in  the  part- 
nership books  to  which  all  assets  should  be  debited  and 
all  liabilities  credited.  This  account  will  then  have  a 
debit  balance  exactly  offsetting  the  total  of  all  the  capi- 
tal account  balances.  An  account  with  the  vendee 
should  then  be  opened  and  debited  with  the  agreed  sale 
price,  the  credit  being  to  the  Realization  and  Liquidation 
account.  The  latter  account  will  then  have  a  credit 
balance  which  will  represent  what  may  be  called  the 
good-will  of  the  partnership. 

The  creation  of  this  good-will  constitutes  a  profit 
which  should  be  divided  among  the  partners  in  their 
profit  and  loss  sharing  ratio.  This  will  leave  the  ac- 
counts as  they  were  under  the  first  assumed  case,  with 
a  debit  balance  against  the  vendee  exactly  offset  by  the 
total  of  the  capital  account  balances.    When  the  vendee 


PARTNERSHIP— DISSOLUTION    ENTRIES         361 

pays,  the  amount  received  should  be  distributed  to  the 
partners,  their  capital  accounts  being  debited  and  the 
vendee's  account  credited.  Thus  all  the  accounts  on  the 
partnership  ledger  are  closed. 


REVIEW  QUESTIONS 

1.  In  what  order  must  the  assets  of  a  firm  be  distributed  upon  its 

dissolution  ? 

2.  What  are  liquidating  dividends  ? 

3.  How  can  overpayment  of  a  partner  be  guarded  against  when 

making  partial  liquidating  dividends? 

4.  Assume  that  four  partners  share  profits  and  losses  1/5,  2/5,  1/4 

and  3/20  and  that  it  is  impossible  to  collect  an  inadvertent 
overpayment  to  the  first  one  upon  dissolution.  What  disposi- 
tion should  be  made  of  the  overpayment? 

5.  Under  what  circumstances  can  a  Good-Will  account  be  created 

upon  the  dissolution  of  a  firm  and  what  should  be  done  with 
its  balance? 


CHAPTER  XXXIII 
CORPORATION   ACCOUNTING 

1.  Nature  of  Corporation 

As  explained  in  Chapter  II,  a  corporation  is  a  group 
of  individuals,  usually  three  or  more,  authorized  by  law 
to  act  in  certain  respects  as  one  person,  with  many  of 
the  rights  and  privileges  accorded  to  persons,  but  sub- 
ject to  many  restrictions  with  which  the  individual  need 
not  comply.  To  comprehend  corporation  accounting, 
it  is  essential  that  the  corporation  be  conceived  as  an 
entity  apart  from  its  proprietors  or  owners. 

2.  Peculiarities  of  Corporation  Accounting 

So  far  as  current  bookkeeping  is  concerned,  the 
only  features  peculiar  to  the  corporation  are  those  con- 
cerning its  capital  investment.  There  are,  however, 
certain  financial  procedures,  such  as  bond  issues  and 
sinking  fund  provisions  (to  be  explained  in  Volume 
IV),  which  are  usually  undertaken  only  by  corpora- 
tions although  there  is  nothing  to  prevent  their  adop- 
tion by  sole  proprietorships  or  partnerships. 

3.  Legal   Requirements 

A  fundamental  legal  requirement  concerning  a 
corporation,  which  is  not  obligatory  in  any  other  form 
of  business  organization,  is  that  capital  originally  in- 
vested in  the  concern  must  not  be  withdrawn  without 
certain  legal  formalities.     The  sole  proprietor  of,  or  a 

362 


CORPORATION    ACCOUNTING  363 

partner  in,  a  business  may  withdraw  his  capital  as  freely 
as  he  pleases,  but  if  a  business  is  organized  in  a  cor- 
porate form,  the  person  or  persons  in  charge  of  the 
company  are  not  permitted  to  withdraw  any  of  the  cap- 
ital originally  invested  unless  certain  rules  of  law  are 
rigidly  complied  with. 

There  is  an  important  reason  for  this  distinction. 
A  sole  proprietor  or  partner  is  personally  liable  to  all 
creditors  of  the  business  to  the  full  extent  of  his  private 
assets.  But  if  the  business  is  organized  as  a  corpora- 
tion, the  corporation  only  is  liable.  When  a  corpora- 
tion has  expended  all  its  assets  in  the  payment  of  cred- 
itors, no  creditor  then  unpaid  has  any  redress  against 
the  persons  who  compose  the  corporation.  For  that 
reason,  the  law  endeavors  to  protect  creditors  by  refus- 
ing to  permit  the  withdrawal  of  capital  after  it  has  been 
invested  in  a  business  conducted  under  the  corporate 
form. 

If  it  were  not  for  this  legal  provision,  a  corporation 
could  be  organized  and  debts  incurred  to  the  extent  of 
its  credit,  after  which  its  owners  could  withdraw  what 
they  personally  had  invested,  leaving  no  assets  other 
than  those  which  the  creditors  themselves  might  have 
contributed — such  as  merchandise,  or  furniture  and  fix- 
tures, or  other  fixed  assets.  Although  the  owners  of  a 
corporation  are  not  permitted  to  withdraw  the  original 
capital,  they  are,  of  course,  permitted  to  withdraw 
profits,  this  being  the  purpose  for  which  every  business 
corporation  is  organized. 

The  capital  originally  invested  in  a  corporation  is 
known  as  its  capital  stock.  The  profits  earned  consti- 
tute part  of  its  surplus  (explained  below),  and  losses 


364         MISCELLANEOUS  ACCOUNTING  TOPICS 

incurred  form  part  of  its  deficit.  The  fundamental 
legal  requirement  is  that  profits  and  losses  from  what- 
ever source  must  be  kept  distinct  from  the  capital  orig- 
inally invested.  This  does  not  imply  an  actual  division 
of  assets  as  between  those  originally  contributed  and 
those  earned.  Such  a  physical  division  or  segregation 
would  be  impossible.  The  law  requires  merely  that  the 
accounts  be  so  kept  that  the  accountability  for  the  orig- 
inal investment  be  distinctly  shown  on  the  corporation 
books. 

4.    Capital  Stock 

Capital  stock  is  the  designation  given  to  the  amount 
originally  invested  as  capital.  Since  there  are  usually 
three  or  more  investors,  accounts  must  be  provided  to 
indicate  clearly  the  exact  amount  contributed  by  each. 
This  is  much  the  same  as  having  a  separate  capital  ac- 
count for  each  partner,  as  discussed  in  Chapter 
XXXI.  But  the  ownership  of  capital  stock  may  be 
widely  distributed  and  easily  transferred  from  one  per- 
son to  another,  and  as  a  rule  the  capital  stock  in  a  cor- 
poration is  held  by  many  individuals.  Therefore  some 
form  of  written  evidence  of  ownership  which  can  be 
passed  from  hand  to  hand  is  needed.  Such  written  evi- 
dence is  known  as  a  "stock  certificate."  Thus  a  stock 
certificate  may  be  defined  as  the  written  evidence  of  the 
amount  invested  by  a  single  stockholder  in  the  capital 
stock  of  a  corporation. 

The  division  of  the  capital  stock  into  shares  is  largely 
left  to  the  discretion  of  the  incorporators,  although  the 
laws  in  many  states  provide  a  minimum  and  a  maxi- 
mum amount  or  value  for  each  share,  known  as  its  "par 


CORPORATION    ACCOUNTING  365 

value."  But  par  value  is  not  necessarily  actual  value. 
If  the  total  capital  stock  is  $100,000  divided  into  1,000 
shares  of  the  par  value  of  $100  each,  this  does  not  mean 
that  each  share  is  worth  $100.  It  means  only  that  each 
share  represents  1/1,000  of  the  total  capital  stock.  The 
capital  stock  of  $100,000  is  worth  exactly  the  excess  of 
the  corporation's  assets  over  its  liabilities — generally 
more  or  less  than  $100,000. 

In  order  to  prevent  fraudulent  misrepresentation 
in  the  handling  of  stocks,  as  for  instance  that  a  share 
of  stock  constitutes  a  demand  against  the  corporation 
for  the  amount  of  its  par  value,  laws  have  recently  been 
passed  permitting  the  issue  of  capital  stock  without  any 
par  value.  Such  stock  is  still  divided  into  shares  but 
each  share  has  only  a  fractional  or  proportionate  value 
of  the  total  capital  stock  to  which  no  money  value  at  all 
has  been  assigned.  Whether  or  not  stock  be  issued 
under  such  a  plan,  the  fact  remains  that  a  share  of  cap- 
ital stock  is  not  an  obligation  or  liability  of  the  corpora- 
tion. It  is  merely  evidence  of  the  accountability  of  the 
corporation  to  the  owner  of  the  stock,  for  that  propor- 
tion of  the  entire  capital  of  the  corporation  which  his 
part  bears  to  the  total  capital  stock. 

A  stock  certificate  may  cover  any  number  of  shares. 
If  a  person  makes  successive  investments  in  a  corpora- 
tion, he  may  receive  a  certificate  upon  each  occasion  to 
show  the  number  of  shares  at  that  time  acquired ;  or  he 
may  surrender  all  previous  certificates  and  receive  a 
new  one  specifying  his  total  holdings.  If  he  desires  to 
sell  or  otherwise  transfer  part  of  the  shares  covered  by 
one  certificate,  e.g.,  200  out  of  500,  he  must  surrender 
the  original  certificate  for  500,  whereupon  the  corpora- 


366         MISCELLANEOUS  ACCOUNTING  TOPICS 

tion  will  issue  two  new  certificates,  one  to  the  transferee 
for  200  shares  and  one  to  the  former  owner  for  300. 

5.    Kinds  of  Capital  Stock 

If  all  the  owners  of  a  corporation  share  profits  on  the 
same  basis,  are  subject  to  like  restrictions,  and  enjoy  the 
same  privileges,  only  one  kind  of  capital  stock  is  issued 
— known  as  common  stock,  because  all  the  owners  are 
interested  in  common.  Sometimes,  however,  it  is  nec- 
essary to  offer  investors  certain  preferences  or  privileges 
in  order  to  induce  them  to  subscribe  for  stock.  For 
example,  persons  may  be  willing  to  invest  in  a  business 
the  future  of  which  is  problematical,  provided  they  can 
secure  the  first  profits  made,  or  provided  they  can  be 
assured  that  if  the  corporation  dissolves,  their  invest- 
ment will  be  paid  to  them  before  any  other  stockhold- 
ers are  reimbursed.  Such  investors  demand  preference 
over  other  stockholders  and,  to  satisfy  them,  a  special 
kind  of  stock  known  as  "preferred"  is  issued.  There 
may  be  first  preferred,  second  preferred,  and  other 
classes  of  preferred  stock.  The  preference  may  relate 
only  to  receiving  a  share  of  profits  before  other  stock- 
holders, or  it  may  relate  to  claims  against  assets  in  case 
of  dissolution,  or  it  may  cover  both  kinds  of  preference. 

The  profits  of  a  corporation  are  divided  among  its 
stockholders  in  proportion  to  the  stock  held  by  each. 
Preferred  stock  is  sometimes  issued  which  provides  that 
if  no  profits  be  earned  in  any  one  year,  subsequent 
profits  must  first  be  distributed  to  the  holders  of  this 
preferred  stock  before  any  can  be  distributed  to  other 
stockholders.  In  other  words,  such  stock  provides  that 
the  profits  payable  to  the  holders  thereof  (who  usually 


CORPORATION    ACCOUNTING  367 

are  entitled  to  profits  to  the  extent  of  some  fixed  per- 
centage of  their  stock)  shall  accumulate.  Such  stock 
is  accordingly  known  as  "cumulative"  preferred  stock 
and  other  preferred  stock  which  does  not  carry  this 
preference  is  known  as  "non-cumulative"  stock. 

Other  kinds  of  stock  may  be  issued  but  the  usual 
classification  is  into  common  and  preferred,  the  latter 
being  subdivided  into  various  classes  such  as  first  or 
second  preferred,  either  of  which  may  be  cumulative  or 
non-cumulative.  A  separate  account  in  the  ledger  must 
be  kept  for  each  kind  of  capital  stock. 

6.    Simple  Opening  Entry 

Upon  the  formation  of  a  corporation,  an  opening 
entry  should  be  made  in  the  general  journal  giving, 
first,  a  brief  summary  of  the  facts  of  incorporation  in 
much  the  same  way  that  the  opening  entry  of  a  part- 
nership summarizes  the  partnership  contract.  This 
journal  entry  should  require  ledger  accounts  for  each 
asset  for  which  capital  stock  has  been  issued,  for  each 
liability  assumed  by  the  corporation  at  its  outset,  and 
for  each  kind  of  capital  stock  issued  in  payment  for  the 
net  worth  acquired.  It  is  necessary  to  show  this  in- 
formation because  the  law  provides  that  capital  stock 
must  be  issued  for  cash  or  other  property  or  for  serv- 
ices of  a  value  not  less  than  the  par  value  of  stock  issued. 

A  simple  example  of  an  opening  entry  is  the  fol- 
lowing : 

May  1,  1920 

The  Acme  Manufacturing  Corporation  was  this 
day  incorporated  under  the  laws  of  the  State  of 
New  York,  with  authorized  capital  stock  of  $100,- 


S68         MISCELLANEOUS  ACCOUNTING  TOPICS 

000  divided  into  1,000  shares  of  a  par  value  of 
$100  each,  for  the  purpose  of  acquiring  and  operat- 
ing the  business  heretofore  conducted  by  Case, 
Nichols,  and  Jensen,  to  whom  the  entire  capital 
stock  has  been  issued  in  exchange  for  the  following 
assets  turned  over  to  the  corporation  and  the  fol- 
lowing liabilities  assumed  by  it: 

Cash    $  1,600.00 

Accounts  Receivable 12,872.00 

Notes  Receivable 3,000.00 

Merchandise  Inventory 64,907.00 

Furniture  and  Fixtures 8,1 12.00 

Machinery  and  Tools 19,509.00 

To  Accounts  Payable $  10,000.0G 

"    Capital  Stock 100,000.00 

7.    Bookkeeping  for  Capital  Stock  Issued 

In  the  above  example,  the  full  amount  of  author- 
ized capital  stoek  is  issued  at  one  time  in  exchange  for 
the  net  free  assets  acquired  by  the  corporation.  Con- 
sequently, the  only  entry  needed  concerning  capital 
stock  is  a  credit  to  the  Capital  Stock  account.  When, 
however,  capital  stock  is  issued  in  instalments,  opinions 
differ  as  to  the  proper  accounting  procedure,  and  the 
bookkeeping  requires  some  discussion. 

The  total  amount  of  capital  stock  authorized  to  be 
issued  must  at  all  times  be  shown  on  the  books  in  order 
to  prevent  the  unintentional  issue  of  more  stock  than 
has  been  authorized  in  the  certificate  of  incorporation. 
To  provide  this  safeguard,  the  procedure  sometimes  is 
to  open  an  account  with  Authorized  Capital  Stock  at  the 
time  the  corporation  is  formed,  debiting  it  and  crediting 
Capital  Stock  with  the  par  value  of  the  entire  authorized 
issue.    When  stock  is  actually  issued,  the  procedure  is  to 


CORPORATION    ACCOUNTING  369 

debit  the  asset  received  for  it  and  to  credit  Authorized 
Capital  Stock.  The  result  is  that  prior  to  the  issue  of  all 
the  capital  stock,  no  one  account  shows  by  its  balance 
the  amount  issued  and  outstanding.  It  is  indicated 
only  by  the  total  credits  in  the  Authorized  Capital 
Stock  account;  it  can  be  calculated  by  subtracting  the 
debit  balance  appearing  in  the  Authorized  Capital  Stock 
account  from  the  credit  balance  in  the  Capital  Stock 
account. 

The  foregoing  procedure  seems  inconvenient  and 
wholly  unnecessary.  The  amount  of  authorized  capital 
stock  can  easily  be  recorded  as  a  memorandum  at  the 
top  of  the  Capital  Stock  account  in  the  ledger,  and  thus 
the  issue  of  stock  is  safeguarded.  /The  simplest  method 
of  recording  issues  of  stock  is  to  make  an  entry  at  the 
time  of  each  issue,  debiting  the  asset  received  and  cred- 
iting Capital  Stock.  Subsidiary  accounts  should  be 
kept  in  a  stock  ledger  to  record  the  number  of  shares 
held  by  each  stockholder.  The  bookkeeping  procedure 
and  the  forms  required  are  described  in  Volume  II, 
"Constructive  Accounting." 

Sometimes,  persons  subscribe  for,  i.e.,  agree  to  take, 
capital  stock  but  do  not  pay  for  it  at  once.  In  such  a 
•case,  the  corporation  acquires  a  number  of  accounts  re- 
ceivable from  the  subscribers  and  an  entry  should  be 
made  debiting  Subscribers  to  Capital  Stock  and  credit- 
ing Capital  Stock.  As  such  subscriptions  are  collected, 
either  in  whole  or  in  instalments,  Cash  should  be  debited 
and  Subscribers  to  Capital  Stock  credited.  In  that  way 
the  asset  of  accounts  receivable  from  subscribers  will 
always  be  apparent  and  all  stock  issued  will  be  shown 
in  one  account. 


370         MISCELLANEOUS  ACCOUNTING  TOPICS 
8.     Opening  Entry  Involving  Good-will 

A  business  is  frequently  sold  for  a  round  sum,  in- 
stead of  for  a  price  based  upon  assets  taken  over  and 
liabilities  assumed.  In  such  a  case,  the  selling  price  is 
generally  in  excess  of  the  book  value  of  the  net  worth 
sold.  This  excess  is  compensation  for  good-will.  Good- 
will is  merely  the  probability  that  its  present  customers 
will  continue  to  patronize  a  business.  A  business  which 
has  been  in  operation  for  some  time  acquires  this  good- 
will from  the  fact  that  its  name  and  location  and  meth- 
ods have  become  known  and  its  customers  generally 
are  more  inclined  to  continue  trading  with  it  than  to 
seek  new  business  connections.  Of  course,  if  a  business 
has  been  poorly  managed,  it  may  have  no  good-will, 
but  upon  the  sale  of  even  a  moderately  well-managed 
business  the  owners  may  reasonably  require  the  pur- 
chaser to  pay  them  something  for  this  element.  It  will 
be  seen  that  good-will  is  an  intangible  asset  which  is 
difficult  to  value.  There  are,  however,  certain  rules  for 
its  valuation,  which  are  discussed  in  Volume  IV. 

Assuming  that  a  corporation  is  organized  to  pur- 
chase a  going  business  for  which  it  pays  a  round  sum 
to  include  good-will,  its  opening  entry  should  indicate 
that  fact  in  some  definite  way.  The  purchase  of  a  busi- 
ness under  such  circumstances  is  not  a  violation  of  law 
because  good-will,  although  intangible,  is  nevertheless 
an  asset  of  value,  and  capital  stock  may  legally  be  is- 
sued for  it.  Its  valuation  should  be  made  by  the  board 
of  directors  of  the  purchasing  corporation.  Bookkeep- 
ing upon  such  purchase  should  indicate,  first,  that  a 
number  of  assets,  the  individual  values  of  all  of  which 
have  not  yet  been  definitely  fixed,  have  been  acquired 


CORPORATION    ACCOUNTING  371 

and  that  the  total  value  of  such  assets  is  equivalent  to 
the  par  value  of  capital  stock  issued  therefor.  The 
best  way  in  which  to  show  this  fact  is  to  make  the  fol- 
lowing entry: 

Plant  and  Sundry  Assets $1 10.000.00 

To  Accounts  Payable $  10,000.00 

Capital  Stock 100,000.00 

After  the  board  of  directors  has  met  and  placed  a 
definite  value  upon  each  asset,  including  the  good-will, 
then  entries  should  be  made  on  the  books  setting  up  an 
account  for  each  asset  so  valued  and  crediting  the  Plant 
and  Sundry  Assets  account.  The  latter  account  is  thus 
used  only  temporarily  to  record  the  total  value  of  all 
assets  secured,  prior  to  their  appraisal  by  the  board  of 
directors. 

9.     Treasury  Stock 

In  the  preceding  sections,  attention  was  called  to 
the  fact  that  not  all  the  authorized  capital  stock  of  a 
corporation  need  be  issued  at  one  time.  The  stock  thus 
left  unissued  is  sometimes  called  "treasury  stock."  This, 
however,  is  wrong.  Treasury  stock  is  stock  which  has 
once  been  issued  but  which  has  been  reacquired  by  the 
corporation  through  donation  or  purchase.  Treasury 
stock  is  usually  secured  to  provide  working  capital  and 
the  method  employed  is,  as  a  rule,  as  follows: 

A  corporation  may  be  organized  to  promote  a  busi- 
ness venture  of  uncertain  future;  e.g.,  one  based  on  a 
patent  still  in  the  experimental  stage  or  a  mining  ven- 
ture. The  entire  capital  stock  of  such  a  corporation  is 
generally  issued  to  the  owner  of  the  patent  or  the  mine. 
In  order  to  observe  legal  requirements,  the  board  of 


372         MISCELLANEOUS  ACCOUNTING  TOPICS 

directors  meets  and  declares  the  invention  or  the  mine 
worth  the  par  of  the  capital  stock  issued  for  it.  After 
the  issue  of  such  stock,  the  corporation  is,  of  course,  in 
no  better  financial  position  than  the  owner  prior  to  the 
formation  of  the  corporation.  In  fact,  it  is  in  a  worse 
position  because  the  expense  of  organization  has  been 
incurred.  In  order  to  secure  cash  capital  with  which  to 
develop  the  project,  outside  investors  must  be  inter- 
ested. It  is  unlikely  that  such  investors  will  be  willing 
to  pay  par  value  for  their  stock  because  of  the  risk  of 
loss;  yet  the  law  requires  that  capital  stock  be  issued 
at  not  less  than  par.  The  following  expedient  known 
as  the  donation  of  stock  is  therefore  resorted  to. 

The  owner  of  the  formula  or  the  mine  who  has  re- 
ceived the  entire  capital  stock  in  exchange  for  his  busi- 
ness, donates  to  the  corporation  a  portion  of  such  stock, 
usually  a  little  less  than  half  of  it.  The  corporation  hav- 
ing received  this  donated  stock  for  nothing,  may  do 
with  it  as  it  likes,  and  proceeds  to  sell  it  at  whatever 
price  can  be  secured.  It  is  not  uncommon  to  find  such 
stock  selling  at  10  cents  on  the  dollar.  The  new  in- 
vestor in  such  a  case  acquires  stock  of  the  par  value  of 
$100  at  a  cost  of  $10.  He  is  willing  to  pay  $10  for 
$100  par  value,  because  if  the  project  fails,  his  loss  will 
not  be  heavy  and  if  it  proves  successful  he  makes  much 
more  than  a  normal  return  on  his  investment. 

The  procedure  of  donating  stock  in  this  way  is  thus 
seen  to  be  a  thinly  veiled  subterfuge  by  which  the  spirit 
of  the  law  is  evaded  while  its  letter  is  complied  with. 
The  board  of  directors'  valuation  of  the  assets  for  which 
the  capital  stock  was  originally  issued  cannot  be  dis- 
puted unless  there  is  clear  evidence  of  fraud.     Since 


CORPORATION    ACCOUNTING  373 

proving  fraud  is  one  of  the  most  difficult  procedures 
known  in  the  law,  it  rarely  happens  that  the  board's 
valuation  is  disturbed.  The  net  effect,  so  far  as  the 
public  is  concerned,  is  that  stockholders  actually  con- 
tribute less  than  the  par  value  of  their  stock. 

Stock  donated  in  this  way  and  sold  for  what  it  will 
bring,  produces  cash  for  which  the  business  is  account- 
able only  to  the  stockholders,  and  this  cash  is  generally 
used  for  the  working  capital  required  in  the  promotion 
of  the  project.  The  bookkeeping  for  such  transactions 
and  that  required  for  the  handling  of  treasury  stock 
which  is  purchased  instead  of  being  received  by  dona- 
tion, will  be  described  in  Volume  IV. 


REVIEW  QUESTIONS 

1.  Compare  a  partnership  with  a  corporation  with  regard  to  special 

features  of  corporation  accounting,  assuming  the  business  in 
each  case  is  the  same. 

2.  Compare  the  opening  entry  for  a  corporation  with  that  for  a 

partnership  and  with  that  for  a  sole  proprietorship. 

3.  Define    capital    stock    and    distinguish    between    the    different 

kinds. 

4.  Define   good-will.      How    is   it   incorporated    into   the   opening 

entry  of  a  corporation? 

5.  Define  treasury  stock. 

6.  A  corporation  is  formed  with  a  capital  stock  of  $100,000  en- 

tirely subscribed  for  and  with  three-fifths  paid  in  cash.    Make 
journal  entries. 


Part  VI 
Single-Entry  Bookkeeping 


CHAPTER    XXXIV 

PRINCIPLES    OF    SINGLE-ENTRY    BOOK- 
KEEPING 

1.      Fundamental   Characteristic   of   Single-Entry   Book- 
keeping 

The  fundamental  characteristic  of  single-entry 
bookkeeping  and  the  one  which  distinguishes  it  from 
other  systems  is  the  fact  that  it  keeps  only  personal  ac- 
counts in  the  ledger.  From  the  analysis  of  a  business 
transaction  given  in  Chapter  IV,  "Double-Entry  Book- 
keeping," it  is  evident  that  the  recording  of  money, 
tangible  assets,  income,  and  expense  is  not  so  important 
as  the  recording  of  personal  obligations,  because  trouble- 
some misunderstandings  may  readily  arise  concerning 
the  latter.  In  single-entry  bookkeeping  the  keeping  of 
ledger  accounts,  which  constitute  the  most  permanent 
and  formal  record,  is  confined  to  the  most  important 
kind  of  recording,  namely,  that  concerning  personal 
obligations.  Of  course,  the  original  entries  should  dis- 
close the  other  factors  involved  in  each  transaction. 

Whenever  under  single-entry  bookkeeping  accounts 
of  things  or  services  are  kept,  they  are  known  as  mem- 
orandum accounts  and  are  not  entitled  to  the  full  faith 
and  credit  given  to  an  account  kept  under  the  double- 
entry  system  whereby  its  accuracy  is  automatically 
checked.  Examples  of  single-entry  memorandum  ac- 
counts are  those  that  record  wages,  rent,  sales,  and  the 
like. 

877 


378  SINGLE-ENTRY    BOOKKEEPING 

2.  The  Day-Book 

In  single-entry  bookkeeping  all  original  entries 
that  do  not  involve  cash  are  made,  day  by  day,  as  they 
occur,  in  a  day-book.  This  record  constitutes  a  sort  of 
diary  showing  transactions  in  chronological  order. 
In  single-entry  bookkeeping  there  are  two  books 
of  original  entry,  the  day-book  and  the  cash  book. 
Transactions  not  involving  cash  are  entered  first  on 
the  day-book.  Cash  transactions  are  entered  first  in 
the  cash  book. 

The  day-book  may  be  in  any  form  convenient  for 
the  business,  but  the  form  in  common  use  and  the 
method  of  making  the  entries  generally  adopted  are 
illustrated  in  the  form  on  page  379. 

Some  day-books  have  two  columns  instead  of  one  at 
the  right-hand  edge,  so  that  the  inner  one  may  be  used 
for  detail  figures;  for  instance,  the  details  of  invoices 
received  and  sent.  In  order  to  avoid  creating  in  the 
reader's  mind  any  possible  confusion  between  the  day- 
book and  the  journal,  the  day-book  is  here  shown  with 
one  column  only  and  the  details  of  the  invoices  are  en- 
tered in  the  explanation  space. 

3.  Requirements  for  the  Day-Book 

The  only  requirements  for  the  day-book  are  that  it 
show  the  name  of  the  person  whose  account  is  affected, 
the  amount  involved,  and  the  particulars  concerning 
the  transaction,  so  that  they  may  be  looked  up,  if  nec- 
essary, at  any  subsequent  time.  Since  the  name  of  the 
person  whose  account  is  affected  is  more  important  than 
the  particulars  of  the  transaction,  the  name  is  entered 
first  and  is  given  a  space  free  from  any  other  writing. 


PRINCIPLES    OF    SINGLE-ENTRY 


379 


DAY-BOOK 

June,  1919 


210 


171 


20- 


Lasker  &  Edwards 


James  E.  Curtis 


Purchase    of    Mdse.    in- 
voiced as  follows: 
30    bbls.    Grade 

A  at  $3.00         $90.00 
10    bbls.    Grade 

B  at  $2.00  20.00 


Sale  of  Mdse.    billed   as 
follows: 
11    bbls.    Grade 

A  at  $4.00        $44.00 
2    bbls.    Grade 
B  at  $3.00  6.00 


$110.00 


50.00 


Form  17.    Day-Book 

The  object  of  this  is  to  provide  ample  room  for  the 
quick  and  legible  writing  of  the  names. 

Most  day-books  are  ruled,  as  in  Form  17  above,  with 
a  column  at  the  extreme  left  for  the  date,  but  actual 
usage  generally  puts  the  name  of  the  month  at  the  top 
of  the  page  and  the  day  of  the  month  in  the  center  im- 
mediately over  the  transactions  for  the  day.  If  this 
plan  be  followed,  each  day's  transactions  will  stand  out 
more  clearly  as  a  unit  by  being  divided  into  sections, 
than  they  would  if  the  dates  were  placed  at  the  left. 
The  year  should  be  written  after  the  month.    The  col- 


380  SINGLE-ENTRY    BOOKKEEPING 

umn  to  the  left  designed  for  the  day  of  the  montli  is 
frequently  used  for  the  ledger  folio  after  posting. 

4.      Inclusiveness  of  the  Day-Book 

It  will  be  noted  that  both  sales  and  purchases  are 
entered  in  the  day-book.  Entries  should  also  be  made 
for  every  other  transaction  not  involving  the  immediate 
receipt  or  payment  of  money.  If,  for  example,  the  busi- 
ness whose  day-book  appears  in  Form  17,  gives  to 
Lasker  &  Edwards  a  draft  drawn  by  it  on  James  E. 
Curtis,  an  entry  recording  the  draft  should  be  made  in 
the  following  manner: 

—22— 

Lasker  &  Edwards  Draft  on  James  E.  Curtis  ac- 

cepted by  him,  due  30  days. 
Sent  to  Lasker  &  Edwards 
on  account.  $50.00 

James  E.  Curtis  Draft  on  him  in  settlement  of 

his  account.  50.00 

Two  entries  are  made  for  what  appears  to  be  one 
transaction,  but  this  does  not  make  the  system  a  double- 
entry  one,  because  there  are  actually  two  transactions 
with  but  one  entry  for  each. 

To  add  the  figures  in  the  money  column  in  the  day- 
book would  be  not  only  unnecessary  but  misleading. 
This  column  contains  figures  covering  a  variety  of  tran- 
sactions and  the  total  would  be  meaningless.  If  the 
business  were  large  enough  to  warrant  it,  more  than 
one  day-book  could  be  used,  and  in  that  event  if  one 
were  used  only  for  sales,  one  only  for  purchases,  and 
one  for  other  transactions,  the  first  two  could  each  be 
added  to  show  the  total  purchases  and  the  total  sales 
for  any  fixed  period.    The  memoranda  thus  introduced 


PRINCIPLES    OF    SINGLE-ENTRY  881 

into  the  books  would  be  of  value,  although  the  figures 
could  not  be  absolutely  relied  upon  unless  the  practice 
were  carried  out  in  sufficient  detail  to  make  the  book- 
keeping double-entry. 

5.  Necessity  and  Methods  of  Posting  to  Ledger 

As  was  pointed  out  in  previous  chapters,  it  is  neces- 
sary for  practical  purposes  to  collect  all  the  entries  con- 
cerning each  person  and  group  them  in  one  place,  the 
ledger,  so  that  the  sum  and  the  net  result  of  the  transac- 
tions with  him  can  be  quickly  ascertained.  In  the  cases 
given,  postings  would  be  made  to  the  account  of  Lasker 
&  Edwards  and  to  that  of  James  E.  Curtis.  After  post- 
ing has  been  completed,  but  not  before,  the  page  of  the 
ledger  on  which  appears  the  account  to  which  the  post- 
ing has  been  made,  should  be  noted  on  the  book  of  orig- 
inal entry  opposite  the  entry  of  the  transaction  posted, 
and  then  in  the  ledger  account  a  similar  record  should 
be  made  of  the  page  of  the  book  of  original  entry  from 
which  the  posting  is  made. 

6.  The  Ledger 

Form  18  shows  the  postings  of  entries  from  the  day- 
book to  ledger  accounts.  This  is  the  usual  form  of  post- 
ing. It  will  be  noticed  that  each  account  is  divided  by 
a  line  drawn  through  the  center  so  that  it  has  two  sides 
in  the  same  manner  as  an  account  under  the  double-entry 
system.  In  single-entry  bookkeeping,  informality  is 
occasionally  carried  to  the  point  where  only  one  side  of 
an  account  is  used,  items  of  an  opposite  nature  being 
subtracted  from  the  total  of  the  other  preceding  items. 
Inexperienced  bookkeepers  have  been  known  to  use  first 


382 


SINGLE-ENTRY    BOOKKEEPING 


Lasker  &  Edwards 

1919 

1919 

June 

~*r> 

Draft  on  Curtis 

due  7/22/19 

D13 

$50.00 

June 

20 

Purchase 

Dll 

$110.00 

James  E.  Curtis 

1919 

1919 
June 

22 

Draft  accepted 

June 

JO 

3ale 

dh 

$50.00 

due  7/22/19 

D13 

$50.00 

Form  18.   Ledger  Accounts,  showing  Postings  from  Day-Book 

the  left-hand  side  of  an  account  and  then  to  carry  the 
total  to  the  top  of  the  right-hand  side,  continuing  the 
entries  on  the  same  page.  Such  practice,  while  designed 
to  save  the  expense  of  paper,  is  likely  to  cause  a  much 
greater  expense  through  the  loss  of  time  due  to  in- 
accuracies. 


7.     The  Cash  Book 

In  single-entry  bookkeeping  much  importance  at- 
taches to  the  cash  book  record.  In  the  absence  of  any 
test  like  a  trial  balance,  the  careful  record  of  cash 
assumes  much  importance.  The  cash  book  in  single- 
entry  bookkeeping  is  in  effect  an  account  with  cash  but. 
as  no  account   is   kept   in   the   ledger,   the    statement 


PRINCIPLES    OF    SINGLE-ENTRY 


383 


CASH  RECEIPTS 

June,  1919 

1919 

June 

1 

Balance 

$2,127.89 

1 

Chas.  E.  Brown 

On  acct. 

157 

125.00 

Joseph  P.  Burnet 

Bill  5/16/19 

165 

72.82 

2 

Cash  Sales  for  the  day 

Mdse.  Grade  A,  2  bbls. 

at  $4.00 

V 

8.00 

CASH  PAYMENTS 


June,  1919 


1919 
June 


Baldwin  &  Co. 
Rent  for  June 
Office  Wages 


Invoice  5/2/19 


220 
V 
V 


$173.50 

150.00 

35.00 


Form  19.     Cash  Book  under  Single-Entry  Bookkeeping  (left-  and  right-hand 

pages) 

made  in  §  1  that  ledger  accounts  are  kept  with  per- 
sons only  is  not  negatived  by  the  keeping  of  a  cash  book. 
The  cash  book  is  thus  more  than  a  book  of  original 
entry;  it  is  also  a  sort  of  account,  since  it  shows  all 
moneys  received  and  paid  out,  and  in  this  way  indicates 
the  balance  of  cash  on  hand.  In  practically  every  busi- 
ness cash  transactions  exceed  in  number  all  other  trans- 
actions, so  that  the  keeping  of  the  day-book,  in  which 
all  entries  might  be  made,  is  much  simplified  by  the  use 
of  a  cash  book  for  the  original  entry  of  cash  receipts  and 
payments. 


384  SINGLE-ENTRY    BOOKKEEPING 

Form  19  illustrates  a  convenient  cash  book  for  sim- 
ple single-entry  bookkeeping.  In  this  illustration  the 
left-hand  page  of  the  cash  book  is  shown  above  the 
right-hand  page,  but  in  actual  use  the  pages  are  oppo- 
site each  other  when  the  book  is  opened. 

Personal  debits  or  credits  are  posted  from  the  cash 
book  to  the  personal  accounts  in  the  ledger  affected  by 
the  transactions. 


REVIEW  QUESTIONS 

1.  Differentiate  between  single  and  double  entrj-. 

2.  What  advantages  has  single-entry  bookkeeping? 

3.  Enumerate  three  important  kinds  of  information  which  may  be 

secured  from  a  set  of  double-entry  records  but  not  from  a  set 
of  single-entry  records. 


CHAPTER    XXXV 
SINGLE-ENTRY  STATEMENTS 

1.  Insufficiency  of  Single-Entry  Ledger  Accounts 

In  single-entry  bookkeeping,  ledger  accounts  are 
kept  with  persons  only,  although  a  record  of  cash  is  main- 
tained in  a  cash  book.  It  follows  that  the  single-entry 
ledger  does  not  usually  show  the  assets  of  a  business, 
other  than  the  accounts  receivable,  although  it  should 
disclose  all  its  liabilities,  since  liabilities  are  amounts 
due  to  persons  and  would  therefore  require  accounts 
with  those  persons. 

Among  the  assets  not  usually  shown  by  the  single- 
entry  ledger  are  those  not  intended  for  sale,  such  as 
furniture,  fixtures,,  and  machinery;  and  the  intangible 
assets,  such  as  good-will  and  trade-marks,  rent,  in- 
surance, and  similar  expenses  paid  in  advance.  Conse- 
quently, in  order  to  determine  the  financial  condition  of 
a  business  the  books  of  which  are  kept  by  single  entry, 
it  is  necessary  to  determine  the  assets,  other  than  the 
balances  of  cash  and  balances  of  the  accounts  receivable, 
from  sources  outside  the  ledger. 

2.  Statement  of  Condition 

In  order  to  show  the  financial  condition  of  a  busi- 
ness in  which  records  are  kept  by  single  entry,  a  "state- 
ment of  condition"  is  prepared,  usually  showing  on  one 
side  of  the  page  all  the  assets  and  on  the  other  all  the 
liabilities  and  the  capital.     If  the  liabilities  exceed  the 

.-185 


386  SINGLE-ENTRY    BOOKKEEPING 

assets,  the  statement  will  show  a  deficit,  which,  as  already 
defined,  is  the  excess  of  liabilities  over  assets. 

The  term  "balance  sheet"  should  not  be  used  to  de- 
scribe such  a  statement  of  condition,  because  there  is 
nothing  akin  to  the  equilibrium  of  accounts  as  in  dou- 
ble entry.  Neither  should  the  term  "statement  of  af- 
fairs" be  used,  that  term  being  confined  to  a  statement 
of  condition  of  a  business  about  to  be  liquidated  because 
of  insolvency  or  for  any  other  reason. 

The  "statement  of  condition"  should  be  dated  in 
such  a  way  as  to  show  the  exact  date  on  which  the  con- 
dition existed,  as  for  example  December  31,  1918.  It 
would  be  inexact  to  head  such  a  statement  "for  the  year 
ending  December  31,  1918."  It  applies  only  to  the  con- 
dition of  the  business  on  a  specified  date. 

3.  The  Form  of  the  Statement 

There  is  no  prescribed  form  of  statement.  The 
form  should  be  such  as  to  indicate  clearly  its  contents 
and  to  present  in  a  readable  manner  the  ideas  intended 
to  be  conveyed.  Sometimes  such  a  statement  is  pre- 
pared with  the  assets  listed  on  the  left  side,  and  the 
liabilities  and  capital  on  the  right,  and  so  arranged  that 
the  totals  are  of  equal  amount  and  opposite  each  other. 
This  form  of  statement  resembles  a  balance  sheet,  but 
it  should  not  be  so  entitled. 

4.  The  Simplest  Form  of  Statement 

A  convenient  form  for  use  by  business  men  who  are 
not  accustomed  to  the  technique  of  bookkeeping  ar- 
ranges the  items  in  a  single  series  as  shown  on  the  fol- 
lowing page : 


SINGLE-ENTRY    STATEMENTS  387 

STATEMENT  OF  CONDITION 

December  31,  1918 
Assets : 

Cash    $  1,500.00 

Notes  Receivable 2,000.00 

Accounts  Receivable 8,000.00 

Merchandise   (Inventory) 7,500.00 

Furniture  and  Fixtures  (Inventory) 300.00 

Machinery  and  Tools  (Inventory) 2,000.00 

Land  and  Buildings  (Inventory) 12,000.00 

Total    $33,300.00 

Liabilities : 

Notes  Payable $   1,000.00 

Accounts   Payable 13,000.00 

Total    1  i,000.00 

Capital    $1 9,300.00 


5.      Comparative  Statement  of  Condition 

Since  a  statement  of  condition  shows  merely  the 
financial  condition  of  the  business  on  a  particular  date, 
it  is  evident  that  the  progress  made  since  some  preced- 
ing date  would  not  be  disclosed  by  it.  For  example,  a 
statement  showing  the  condition  on  December  31,  1918 
would  not  indicate  any  of  the  changes  during  the  year. 
If  the  statement  of  December  31,  1918  be  compared 
with  one  of  January  1,  1918,  the  net  change  in  each 
asset  and  liability  and  in  the  capital  will  be  disclosed. 
Such  statements  may  be  combined  in  what  is  called  a 
comparative  statement  of  condition,  in  which  both  as- 
sets and  liabilities  are  listed  in  two  columns,  one  for 
each  date,  and  the  differences  between  them  noted  as 


388  SINGLE-ENTRY    BOOKKEEPING 

increases  or  decreases.  The  following  is  an  example  of 
such  a  comparative  statement  arranged  in  running  form, 
liabilities  being  deducted  from  assets  to  determine 
capital. 

COMPARATIVE    STATEMENT    OF   CONDITION 
December  31,   1918 — January   1,   1918 

.  Dec.  31,  Jan.  1,  T  ^ 

Assets  1918  1918  Increase      Decrease 

Cash  $  1,500.00  $  2,000.00                                $   500.00 

Notes  Receivable 2,000.00  1,000.00           $1,000.00 

Accounts  Receivable 8,000.00  6,000.00             2,000.00 

Merchandise  Inventory. .  . .  7,500.00  9,500.00                                  2,000.C0 

Furniture  and  Fixtures...  300.00  275.00                 25.00 

Machinery  and  Tools 2,000.00  1,800.00                200.00 

Land  and  Buildings 12,000.00  12,000.00 

$33,300.00       $32,575.00  $3,225.00       $2,500.00 

Liabilities 

Notes    Payable $  1,000.00       $  1,500.00  $    500.00 

Accounts   Payable 13,000.00         11,000.00  $2,000.00 

$14,000.00       $12,500.00  $2,000.00       $    500.00 

Capital   $19,300.00       $20,075.00  $    775.00 


6.     Inadequacy   of   Comparative   Statement 

The  above  statement  shows  the  net  changes  includ- 
ing the  decrease  in  capital,  but  it  does  not  disclose  the 
reasons  for  the  changes.  It  does  not  indicate  whether 
the  business  has  made  a  profit  or  incurred  a  loss,  al- 
though it  shows  that  the  capital  has  been  decreased.  It 
does  not  show  the  profit  or  loss  because  it  does  not  in- 
dicate what  the  proprietor  may  have  withdrawn  during 
the  year  or  what  he  may  have  contributed  as  new  cap- 


SINGLE-ENTRY    STATEMENTS  38!) 

ital  This  statement  may  be  altered  so  as  to  reveal  the 
net  profit  or  loss  by  showing  the  drawings  and  contri- 
butions. Assuming  that  there  have  been  no  contribu- 
tions but  that  the  proprietor  has  withdrawn  $1,500  for 
his  personal  use,  the  net  profit  would  be  indicated  as 
$725.  This  can  be  shown  more  clearly  by  a  summary 
of  changes  in  assets  and  liabilities  in  the  following  form: 

SUMMARY  OF  CHANGES  OF  ASSETS  AND  LIABILITIES 

During  the  year  ended  December  31,   1918 

Decrease  in  Merchandise   Inventory $2,000.00 

Decrease  in  Cash    500.00 

Increase  in   Accounts   Payable 2,000.00     $1,500.00 

Increase  in  Accounts    Receivable $2,000.00 

Increase  in   Notes  Receivable 1,000.00 

Increase  in   Machinery  and  Tools 200.00 

Increase  in   Furniture  and   Fixtures •_'.">. 00 

Decrease  in   Notes    Payable 500.00        0.725.00 

Net  Decrease  in  Capital $     775.00 

Proprietor's  Drawings 1 .500.00 

Net  Profit $    725.00 


7.     Method   of  Determining  Profit  or  Loss 

The  factors  of  changes  in  capita]  arc  four,  two  caus- 
ing increases  and  two  causing  decreases.  Those  which 
increase  capital  are  profits  earned  and  additional  assets 
contributed  by  the  proprietor;  those  which  decrease 
capital  are  losses  incurred  and  assets  withdrawn  by  the 
proprietor.  It  is  evident,  therefore,  that  if  capital  has 
increased  and  we  desire  to  know  how  much  of  the  in- 


390  SINGLE-ENTRY    BOOKKEEPING 

crease  is  due  to  profits  earned  by  the  business,  we  can 
determine  this  by  eliminating  the  increase  due  to  addi- 
tional contributions  by  the  proprietor.  To  illustrate, 
if  the  capital  has  increased  $10,000  and  the  proprietor 
has  contributed  $6,000,  which  contribution  is  recorded 
in  his  proprietorship  account,  the  increase  due  to  profits 
must  have  been  $4,000.  Likewise,  if  the  capital  has 
decreased  $1,200  and  the  proprietor  from  an  examina- 
tion of  his  bank  account  notices  that  he  has  withdrawn 
$1,000  for  personal  use,  the  decrease  due  to  loss  must 
have  been  $200. 

In  actual  practice,  however,  the  situations  are  not 
as  simple  as  these.  Frequently  there  are  contributions 
of  capital  as  well  as  withdrawals  by  the  proprietor,  and 
often  the  withdrawals  exceed  the  decrease  in  capital  and 
the  contributions  exceed  the  increase  in  capital.  Con- 
sequently it  is  sometimes  puzzling  to  determine  the  ex- 
act profit  or  loss  by  the  method  suggested  in  the  pre- 
ceding paragraph  without  definite  rules  for  guidance. 
These  rules  may  be  expressed  in  the  formulas  given 
below. 

8.     Formulas   for   Determining   Profit   or   Loss 

In  the  following  formulas  the  words  "increase"  and 
"decrease"  relate  to  the  capital  and  not  to  specific  assets 
or  liabilities.  The  word  "contributions"  means  increases 
in  capital  due  to  contributions  of  new  assets  by  the  pro- 
prietor. The  word  "withdrawals"  means  assets  with- 
drawn by  the  proprietor  or  his  personal  liabilities  as- 
sumed by  the  business.  The  word  "profit"  and  the 
word  "loss"  mean  the  profit  or  loss  earned  by  the  opera- 
tions of  the  business. 


SINGLE-ENTRY    STATEMENTS  ,'391 

1.  Increase  -f~  withdrawals    =  profit 

2.  Increase  —  contributions  =  profit 

3.  Contributions  —  increase  =  loss 

4.  Decrease  -\-  contributions  =  loss 

5.  Decrease  —  withdrawals    =  loss 

6.  Withdrawals    —  decrease  =  profit 

Where  there  are  both  withdrawals  and  contributions 
the  net  amount  should  be  determined  and  treated  as 
a  contribution  or  a  withdrawal,  whichever  is  the  case. 

These  formulas  are  easy  to  apply  when  the  amount 
of  capital  at  the  beginning  and  at  the  end  of  the  period 
under  review  has  been  determined  and  the  amount  of 
drawings  and  contributions  ascertained.  A  few  ex- 
amples will  make  this  clear: 

1.  If  the  capital  has  increased  $1,500  and  the  pro- 
prietor has  withdrawn  $2,000,  the  profit  must  have  been 
$3,500.  This  can  be  demonstrated  by  considering  what 
the  increase  in  capital  would  have  been  if  the  proprietor 
had  not  withdrawn  anything.  In  that  case  the  assets 
would  have  been  $2,000  more  than  they  were  at  the  end 
of  the  year,  and  thus  the  increase  in  capital  would  have 
been  $2,000  more,  or  $3,500  in  all.  An  increase  in  cap- 
ital in  the  absence  of  contributions  or  withdrawals  would 
be  due  only  to  profits  earned  by  the  business;  hence  the 
profit  would  clearly  have  been  $3,500.  The  fact  that 
the  proprietor  withdrew  $2,000  would  not  in  any  way 
affect  the  profits  earned  by  the  operation  of  the  business. 

2.  Assuming  an  increase  in  capital  of  $4,000  but  a 
contribution  of  $1,000,  the  amount  of  the  increase  due 
to  profits  must  have  been  $3,000,  because  if  the  pro- 
prietor had  not  contributed  the  $1,000  the  increase  in 
capital  would  have  been  $3,000. 


392  SINGLE-ENTRY    BOOKKEEPING 

3.  If,  on  the  other  hand,  the  contributions  by  the 
proprietor  have  been  $6,000  and  the  capital  has  in- 
creased only  $4,000,  it  is  evident  that  there  must  have 
been  a  loss  of  $2,000  because  otherwise  the  capital  would 
have  increased  by  the  amount  of  the  contribution. 

4.  If  the  capital  has  decreased  $3,000  despite  a 
contribution  of  $4,000,  there  must  have  been  a  loss  of 
$7,000  because  the  business  has  lost  not  only  the  $4,000 
contributed  by  the  proprietor  but  $3,000  in  addition,  or 
a  total  of  $7,000.  In  other  words,  the  business  is  $3,000 
worse  off  than  at  the  beginning  of  the  period,  notwith- 
standing the  fact  that  the  proprietor  contributed  $4,000. 

5.  If  the  capital  has  decreased  $1,500  but  the  pro- 
prietor has  withdrawn  $1,000,  the  loss  must  have  been 
$500  because  his  withdrawals  of  $1,000  contributed  to 
the  decrease  in  capital. 

6.  If,  on  the  other  hand,  the  proprietor  has  with- 
drawn $2,500  but  the  capital  has  decreased  only  #1,500, 
the  business  must  have  made  a  profit  of  $1,000  because 
if  the  proprietor  had  not  withdrawn  $2,500  the  capital 
would  have  been  increased  by  $1,000  instead  of  de- 
creased by  $1,500. 

9.    The  Asset  and  Liability  Method 

This  method  of  determining  profit  or  loss  is  known 
as  the  asset  and  liability  method  because  assets  and 
liabilities  at  the  beginning  and  at  the  end  of  the  period 
must  be  ascertained  in  order  to  determine  changes  in 
capital.  If  accounts  have  been  kept  for  such  items  as 
rent,  insurance,  sales,  or  the  like,  they  should  not  be  used 
in  determining  the  profit  or  loss  under  single  entry,  but 
the  method  used  should  be  strictly  that  outlined  above. 


SINGLE-ENTRY    STATEMENTS  393 

The  reason  is  that  such  accounts  as  those  mentioned 
would  not  be  reliable  unless  a  complete  system  of  dou- 
ble-entry bookkeeping  were  employed. 

Instead  of  adding  the  withdrawals  to  the  increase 
in  capital  in  order  to  determine  the  profit  as  provided 
in  the  first  formula,  one  may  deduct  the  drawings  from 
the  capital  at  the  beginning  of  the  period,  the  profit 
then  being  the  increase  in  capital.  For  example,  ac- 
cording to  the  first  method,  if  the  capital  at  the  begin- 
ning of  a  period  was  $7,000  and  at  the  end  of  the  period 
$8,000,  and  the  drawings  during  the  period  were  $2,000, 
there  would  be  a  profit  of  $3,000.  According  to  the 
second  method,  the  same  answer  can  also  be  secured 
by  subtracting  the  drawings  of  $2,000  from  the  capital 
of  $7,000  at  the  beginning  of  the  period,  leaving  a  cap- 
ital of  $5,000  which  during  the  period  had  increased  to 
$8,000  as  the  result  of  a  profit  of  $3,000.  The  other 
formulas  can  be  adjusted  in  the  same  way. 

The  theory  of  this  alternative  method  is  that  the 
drawings  were  taken  out  of  capital  at  the  beginning  of 
the  period  and  not  out  of  profits,  or  that  contributions 
have  been  made  at  the  beginning  or  end  of  a  period 
rather  than  during  the  period.  It  is  questionable 
whether  this  theory  is  sound  because  drawings  are  us- 
ually made  on  account  of  profits  earned,  since  the  pro- 
prietor generally  does  not  withdraw  his  invested  capital. 

10.    Tangible  and   Intangible  Assets 

In  determining  the  profit  or  loss  under  single  entry 
it  is  not,  strictly  speaking,  proper  to  say  that  only 
tangible  assets  are  considered,  because  tangible  means 
concrete  things  which  have  weight  and  dimensions,  such 


394  SINGLE-ENTRY    BOOKKEEPING 

as  a  table  or  a  machine.  Accounts  receivable,  for  ex- 
ample, would  not  be  tangible  assets  and  yet  they  obvi- 
ously must  be  considered  in  determining  the  profit  or 
loss.  What  is  usually  in  mind  when  the  assertion  is 
made  that  only  tangible  assets  are  considered,  is  prob- 
ably that  assets  such  as  prepaid  insurance,  or  other  de- 
ferred charges,  are  not  to  be  considered.  This,  however, 
is  not  sound.  All  assets  of  every  kind  should  be  con- 
sidered in  determining  the  capital  both  at  the  beginning 
and  at  the  end  of  a  period. 

11.    Inadequacy  of  Single-Entry  Method 

While  the  profit  or  loss  during  a  given  period  can 
be  ascertained  from  single-entry  books  by  the  method 
described  above,  the  showing  is  incomplete.  In  a  pro- 
gressive business  it  is  not  enough  to  know  merely  that 
the  profit  or  loss  has  been  so  many  dollars.  Every  busi- 
ness man  needs  an  analytical  system  of  records  to  give 
the  information  necessary  for  proper  administrative 
control.  The  executive  must  know  how  the  income  has 
been  earned  and  what  items  of  expense  have  been  in- 
volved to  ascertain  whether  or  not  each  source  of  in- 
come is  at  the  maximum,  and  whether  each  expense  is 
being  kept  at  the  minimum.  These  facts  cannot  be  as- 
certained unless  all  business  transactions  are  recorded 
from  day  to  day  in  books  of  account,  which  are  arith- 
metically exact. 

It  is  evident  that  under  single-entry  methods  mem- 
orandum accounts  for  the  various  expenses,  for  example, 
might  have  too  much  or  too  little  debited  to  them  and 
there  would  be  nothing  in  the  accounts  to  call  attention 
to  the  mistake.    The  proprietor  or  the  bookkeeper  could 


SINGLE-ENTRY    STATEMENTS  395 

detect  errors  in  such  accounts  only  intuitively  if  they 
seemed  to  he  wrong  in  amount.  Consequently,  single- 
entry  accounts  cannot  be  relied  upon  for  accuracy.  To 
insure  dependable  statistics,  the  books  should  be  kept 
by  the  double-entry  method. 


REVIEW  QUESTIONS 

George  Crum  begins  business  alone  on  January  1,  1918,  with 
the  following  assets:  cash  $1,687.49;  furniture  and  office  fix- 
tures worth  $417.62;  merchandise  worth  $8,546.48;  and  ma- 
chinery worth  $2,493.61.  Of  the  cash  which  he  invests  in 
the  business,  $1,200  is  borrowed  from  Albert  King.  During 
the  year  he  invests  no  new  assets  and  he  withdraws  nothing 
for  his  personal  use,  but  he  pays  Albert  King  one-half  of  the 
amount  borrowed  from  him. 

On  December  31,  1918  the  business  has  the  following  assets: 
cash  $3,863.52;  furniture  and  office  fixtu/es  worth  $512.67; 
merchandise  worth  $3,218.45 ;  and  machinery  worth  $2,503.96. 
In  addition  to  the  amount  due  Albert  King,  the  business 
owes  Jenks  &  Holden  $124.93  for  merchandise  purchased  on 
credit. 

Has  the  business  made  a  profit  or  incurred  a  loss  and  what  is 
the  amount  of  it? 

Suppose  in  addition  to  the  facts  given  in  Question  1,  Crum  with- 
draws during  the  year  $2,000  for  his  personal  use.  If  the 
assets  at  December  31,  1918  are  the  same  as  those  given  in 
Question  1,  what  was  the  profit  or  loss  of  the  business? 

Suppose  in  addition  to  all  the  facts  given  in  Questions  1  and  2 
that  Crum  during  the  year  invested  $1,000  more  of  his  per- 
sonal cash  in  the  business.  If  the  assets  at  December  31, 
1918  are  the  same  as  those  given  in  Question  1.  what  was  the 
profit  or  loss  of  the  business? 

(a)  What  kind  of  business  organization  did  George  Crum  have 

in  the  case  described  in  Question  1  ? 

(b)  Name  other  forms  of  business  organizations. 


Part  VII 
Account  Classification 


CHAPTER    XXXVI 
ANALYSIS  OF  DEBIT  ACCOUNTS 

1.      Rules  for  Journalizing 

The  rules  for  journalizing  given  in  Chapter  XV 
may  be  summarized  as  follows : 


Debit  an  account  to  record: 

Credit  an  account  to  record: 

1.     Increase  of  an  asset. 

1.    Decrease  of  an  asset. 

2.    Decrease  of  a  liability. 

2.    Increase  of  a  liability. 

3.    An  expense. 

3.    An  income. 

4.    Decrease  of  capital  by  with- 

4.   Increase  of  capital  by   con- 

drawals or  otherwise  than 

tributions      or      otherwise 

by  expense. 

than  by  income. 

In  order  to  fix  clearly  in  mind  the  application  of 
these  rules,  a  number  of  accounts  are  analyzed  in  this 
and  the  following  chapter  showing  the  usual  trans- 
actions debited  and  credited  to  each  of  them. 

2.      The  Trial  Balance 

The  following  trial  balance  contains  typical  accounts 
to  be  found  upon  the  ledger  of  an  average  sized  cor- 
poration before  the  ledger  has  been  closed.  The  debit 
accounts  found  on  this  trial  balance  will  be  analyzed  in 
this  chapter;  the  credit  accounts  in  the  next  chapter. 

First  examine  the  trial  balance  to  see  whether  or  not 
the  account  you  are  seeking  is  listed.  When  that  ac- 
count is  found,  study  its  components  in  the  light  of  the 

399 


400  ACCOUNT    CLASSIFICATION 

TRIAL  BALANCE   (Before  Closing) 


Debits 

Credits 

Cash 

Notes   Payable 

Petty  Cash 

Accounts  Payable 

Accounts  Receivable 

Notes    Receivable    Discounted 

Notes  Receivable 

Accrued  Taxes 

Inventory 

Accrued  Interest  on  Bonds 

Purchases 

Accrued   Interest  on   Mortgages 

Securities  Owned 

Payable 

Mortgages    Receivable 

Capital  Stock  Subscribed 

Subscriptions  to  Capital  Stock 

Bonds 

Instalment  Account 

Mortgages  Payable 

Treasury  Stock 

Bond  Premium 

Organization  Expenses 

Reserve     for     Depreciation     of 

Insurance  Premiums  Prepaid 

Buildings 

Interest   Prepaid 

Reserve  for  Bad  Debts 

Bond  Discount 

Reserve  for  Sinking  Fund 

Office  Supplies 

Surplus 

Land 

Dividends 

Buildings 

Surplus  from  Treasury  Stock 

Furniture  and  Fixtures 

Capital  Stock,  Common 

Sinking  Fund 

Capital  Stock,  Preferred 

Good-Will 

Capital     Stock     with     No     Par 

Returned  Sales 

Value 

Sales   Rebates  and  Allowances 

Sales 

In- Freight 

Cash  Discounts  Received 

Cash  Discounts  Allowed 

Interest 

Depreciation  of  Buildings 

Premium  on   Capital   Stock 

Bad  Debts 

Returned  Purchases 

Interest  on  Bonds 

Purchase    Rebates    and    Allow- 

Interest on   Mortgages   Payable 

ances 

Miscellaneous   Expenses 

Miscellaneous  Income 

Profit  and  Loss 

ANALYSIS    OF    DEBIT    ACCOUNTS 


401 


other  accounts  found  on  the  trial  balance.  This  precau- 
tion is  given  because  by  themselves  certain  accounts  as 
shown  are  incomplete,  whereas,  viewed  in  the  light  of  the 
entire  set  of  accounts,  they  perform  very  important  func- 
tions. 


3.     Detailed   Analyses 


Cash 


Debit: 

1.  Opening     balance     in     bank 

plus  cash  on  hand  (exclu- 
sive of  petty  cash  fund). 

2.  Receipts  each  month.  Posting 

made  at  close  of  month 
from  cash  book  footing. 

3.  Balance      of     this      account 

should  represent  and  agree 
with  the  balance  in  bank 
plus  cash  on  hand  (exclu- 
sive of  petty  cash  fund), 
which  is  a  current  asset. 


Credit: 

1.  Disbursements.  Posting 
made  at  close  of  month 
from  cash  book  footing. 


Petty  Cash 


Debit: 

1.  Amount  of  fund  created. 

2.  Increases  in  amount  of  fund. 
I.    Balance      of      this      account 

should  represent  the  pres- 
ent amount  of  the  fund, 
which  is  a  current  asset. 


Credit  : 

1 .    Decreases  in  amount  of  fund. 


402 


ACCOUNT    CLASSIFICATION 
Accounts  Receivable 


Debit: 

1.  Total      amount     of      sales 

charged  to  customers'  in- 
dividual accounts  from 
the  sales  book — the  total 
footing  of  the  accounts 
receivable  column.  This 
is  done  monthly.  The 
amount  represents  all 
charge  sales  of  month. 

2.  Adjustments       increasing 

amounts  due  from  cus- 
tomers. 

3.  Balance     of    this     account 

should  represent  the  total 
amount  due  from  custom- 
ers as  displayed  in  the 
accounts  on  the  customers 
ledger.  It  represents  a 
current  asset. 


Credit : 

1.  Total   amount   of   credits   to 

individual  customers'  ac- 
counts from  the  cash  book ; 
the  total  footing  of  the 
accounts  receivable  column 
on  receipts  side.  The 
amount  represents  all 
moneys  received  from  cus- 
tomers to  apply  on  open 
account  plus  total  cash 
discounts  allowed  them. 

2.  Returns  by  customers  which 

have  been  credited  to  cus- 
tomers' individual  accounts 
either  from  (a)  returned 
sales  journal,  or  (b)  jour- 
nal, if  no  returned  sales 
journal    is   kept. 

3.  Bad  debts  charged  off,  deb- 

iting at  the  same  time  the 
Reserve  for  Bad  Debts 
account. 

4.  Adjustments      decreasing 

amounts  due  from  cus- 
tomers. 


Notes  Receivable 


Debit: 

Credit  : 

1.    Face  value  of  notes   receiv- 

].    Cash    received    on    notes    re- 

able   received    from    cus- 

ceivable, the  face  value  of 

tomers    or    other    persons, 

notes    sold   and    notes    re- 

whether   original    transac- 

newed. 

tions  or  renewals. 

ANALYSIS    OF    DEBIT    ACCOUNTS 


403 


Notes  Receivable  (Continued) 


Balance  should  represent 
face  value  of  notes  receiv- 
able on  hand  and  notes  re- 
ceivable discounted  at  the 
bank,  the  latter  being  off- 
set by  a  credit  in  the 
Notes  Receivable  Dis- 
counted account.  Notes  re- 
ceivable are  current  assets. 


Inventory 

Debit  : 

Credit: 

1.    Amount  of  goods  on  hand  at 

1.    Amount  of  beginning  inven- 

beginning of  period. 

tory  should  be  transferred 

2.    Amount  of  inventory  at  end 

to  Purchases  account  when 

of  period  as  taken  up  in 

books  are  closed. 

Purchases   account.      This 

posting  is  made  after  this 

account  has  been  closed  by 

credit  entry  (1). 

Purchases 


Debit: 

Credit: 

1.    Cost  of  all  merchandise  pur- 

1. 

Returned  purchases. 

chased    for    trading    pur- 

2. 

Purchase  rebates  and  allow- 

poses. 

ances. 

2.    Freight  and  cartage  in. 

3. 

Inventory — amount  of  goods 

3.     Beginning     inventory     from 

on  hand  at  end  of  period, 

inventorv     account.      This 

debiting     Inventory     ac- 

amount   is    the    inventorv 

count. 

balance  as  it  exists  before 

4. 

Amount  of  balance  should  be 

closing. 

transferred   to   Profit  and 
Loss     so    that     Purchases 
account  will  be  closed. 

4(M 


ACCOUNT    CLASSIFICATION 
Securities  Owned 


Debit: 

Credit: 

1.    Cost  of  stocks  and  bonds  (of 

1. 

Selling   price   of   stocks   ant1 

other    corporations)     pur- 

bonds   (of   other  corpora 

chased.    When  a  corpora- 

tions) sold. 

tion  acquires  its  own  stock, 

2. 

Inventory — amount  of  stocks 

Treasury  Stock  account  is 

and  bonds  on  hand  at  end 

debited     instead     of     the 

of  period,  at  cost  price. 

present  one. 

3. 

Amount  of  balance,  if  debit. 

2.    Amount  of  balance,  if  credit, 

transferred   to   Profit   and 

transferred   to   Profit  and 

Loss,     thus     closing     this 

Loss,     thus     closing     this 

account. 

account. 

3.    Inventory  at  end  of  period, 

per  credit   entry   2.    This 

posting  is  made  after  this 

account  has  been  closed  by 

debit    entry    2    or    credit 

entry  3,  as  the  case  may 

require. 

Mortgages  Receivable 


Debit: 

Credit  : 

1.    Face  value  of  mortgages  re- 

1.   Payments      received,     face 

ceivable  received,  whether 

value    of    mortgages    sold 

original  transactions  or  re- 

or renewed. 

newals    of    former    mort- 

gages. 

2.    Balance    should    represent 

face    value    of    mortgages 

receivable  on  hand.    Thev 

are  current  assets. 

ANALYSIS    OF    DEBIT    ACCOUNTS  KM 

Subscriptions  to  Capital  Stock 


Debit: 

1.  Amount  of  subscriptions  for 

capital  stock  sold  on  the 
instalment  plan,  crediting 
at  same  time  the  Capital 
Stock  Subscribed  account. 

2.  Balance    of    this    account 

should  represent  the 
amount  receivable  but  not 
yet  due  on  subscriptions 
for  capital  stock  sold  on 
the  instalment  plan.  It  is 
offset  by  the  balance  of  the 
Capital  Stock  Subscribed 
account.  It  represents  a 
current  asset  because  its 
balance  will  be  converted 
into  cash. 


Credit  : 

1.  Money  received  to  cover  sub- 

scriptions in  full. 

2.  Amount    of    instalments    as 

they  become  receivable,  the 
debits  being  made  to  In- 
stalment account. 


Instalment  Account 


Credit: 

1.    Cash  received  on  account  of 
instalment  subscriptions. 


Debit: 

1.  Amount   of   instalments   due 

by  subscribers  to  shares  of 
stock,  crediting  Subscrip- 
tions to  Capital  Stock  ac- 
count. 

2.  Balance     represents     instal- 

ments receivable. 


Note:  Account  is  opened  each  time  an  instalment  falls  due,  and 
it  remains  open  until  cash  is  received  in  full  for  the  particular  instal- 
ment. 


406 


ACCOUNT    CLASSIFICATION 
Treasury  Stock 


Debit: 

1.  Par  value  of  treasury  stock 

acquired.  Cash  or  other 
asset  account  is  credited  to 
record  any  consideration 
paid  for  treasury  stock; 
any  difference  between  the 
par  value  and  the  consid- 
eration paid  is  credited  or 
debited  to  Surplus  from 
Treasury  Stock  account, 
as  the  case  may  require. 

2.  Balance    represents   the   par 

value  of  treasury  stock 
on  hand.  The  stock  is  not 
an  asset.  The  balance  of 
the  account  represents  a 
reduction  of  capital  stock 
issued. 


Credit : 

1.  Par  value  of  treasury  stock 
sold  or  otherwise  disposed 
of.  Cash  or  other  asset  ac- 
count is  debited  to  record 
any  consideration  re- 
ceived; any  difference  be- 
tween the  par  value  and 
the  consideration  received 
is  debited  or  credited  to 
Surplus  from  Treasury 
Stock  account,  as  the  case 
may  require. 


Organization  Expenses 


Debit: 

1.  Cost  of  all  organization  ex- 

penses— incorporation  ex- 
penses, attorney's  fees, 
promoters'  services,  etc. 

2.  Balance     of    this     account 

should  represent  the  por- 
tion of  organization  ex- 
penses which  are  to  be 
charged  off  to  Profit  and 
Loss.  It  represents  a  de- 
ferred charge. 


Credit: 

2.  Proportionate  periodical 
amount  of  the  debits  based 
upon  the  number  of  years 
over  which  these  expenses 
are  to  be  spread,  debiting 
Profit  and  Loss  at  the 
same  time. 


ANALYSIS    OF    DEBIT    ACCOUNTS 
Insurance  Premiums  Prepaid 


401 


Debit: 

Credit: 

I.    Amount    of    insurance    pre- 

I. 

Amount    of    refunds    by    in- 

miums prepaid. 

surance  companies. 

2.    Balance    of    this    account 

2. 

Periodical  proportion  of  pre- 

should represent  the  cost 

paid  premiums   which  are 

of  insurance  premiums  un- 

applicable   to    the    period 

expired.     It   represents    a 

just  ended,  debiting  Insur- 

deferred charge. 

ance. 

Interest  Prepaid 


Debit: 

Credit: 

1.    Amount  of   interest   paid   in 

I. 

Periodical  proportion  of  in- 

advance   on     money    bor- 

terest    paid     in     advance. 

rowed. 

debiting  Interest  account. 

2.    Balance    of    this    account 

should      represent     the 

amount    of    interest    paid 

in  advance  which  is  a  de- 

ferred charge. 

Bond  Discount 


Debit: 

Credit: 

1.    Amount  of  discount  allowed 

1.    Proportionate  amounts  writ- 

on sale  of  company's  bonds. 

ten     off     periodically     to 

2.    Amount  of  other  bond  issue 

Profit  and  Loss  account. 

expenses    incurred   at   the 

date  of  issue. 

3.    Balance     represents     a     de- 

ferred   charge,    to    be 

charged  off  during  the  life 

of  the  bonds. 

108 


ACCOUNT    CLASSIFICATION 
Office  Supplies 


Debit: 

1.  Cost  of   office   supplies   pur- 

chased in  such  large  quan- 
tities that  some  of  them 
are  sure  to  be  on  hand 
when  the  first  profit  and 
loss  statement,  following 
their  purchase,  is  made  up. 

2.  Balance  of  this  account  repre- 

sents cost  of  office  supplies 
on  hand.  Strictly  speaking, 
this  is  an  asset  but  it  is 
more  conservative  to  regard 
it  as  a  deferred  charge. 


Credit : 


Periodical  proportion  of  cost 
of  office  supplies  used, 
debiting  the  proper  ex- 
pense  accounts    therefor. 


Land 


Debit: 

1.  Cost  of  land  acquired. 

2.  Expenses  incident  to  acquir- 

ing title — legal  fees,  re- 
cording fees,  etc. 

3.  Cost  of  improvements — grad- 

ing, road  building,  curb- 
ing, etc. 

4.  Cost  of  surveys,  maps,  etc. 

5.  Carrying  charges  until  build- 

ings are  erected,  or  until 
land  becomes  productive — 
taxes,  interest  on  mort- 
gage, etc. 

6.  Balance    of    t  h  i  s    account 

should  represent  the  cost 
of  land  owned  which  is  a 
fixed  asset. 


Credit: 

1.  Selling   price   of   land   sold. 

2.  The   profit  or  loss   on  sales 

should    be    transferred    to 
Surplus  account. 


ANALYSIS    OF    DEBIT    ACCOUNTS  409 

Buildings 


Debit: 

1.    Cost  of  buildings  acquired. 


Credit : 


Cost  of  buildings  destroyed. 
Selling    price    of    buildings 

sold. 
The  profit  or   loss  on   sales 

should    be    transferred    to 

Surplus  account. 


2.  Construction  cost  when  con- 

structed. 

3.  Cost  of  all  additions. 

4.  Cost  of  alterations  which  in- 

crease usefulness  or  actual 

value  of  buildings. 
•").    Excess    of   replacement  cost 

over  original  cost  of  part 

replaced, 
fi.    Balance    of    this    account 

should   represent  the   cost 

of  buildings  owned,  which 

are  fixed  assets. 

Note  1.  If  the  purchase  price  of  real  estate  includes  both  land 
and  buildings,  it  should  be  analyzed  and  the  estimated  cost  of  each 
charged  to  its  account. 

2.    This  account  may  be  subdivided  as  may  be  desirable. 

Furniture  and  Fixtures 


Debit: 

1.  Cost    of    furniture    and    fix- 

tures acquired,  including 
cost  of  transportation  and 
installation. 

2.  Cost    of    all    additions    and 

betterments. 

3.  Balance    of    this    account 

should  represent  the  cost 
of  furniture  and  fixtures 
owned,  which  is  a  fixed 
asset. 


Credit: 

1.  Cost  of  furniture  and  fix- 
tures replaced  or  dis- 
carded, debiting  (a)  cash 
or  its  equivalent  f"r  the 
amount  received  if  furni- 
ture and  fixtures  have 
been  sold;  and  (b)  Re- 
serve for  Depreciation  of 
Furniture  and  Fixtures  for 
the  difference  between  the 
cost  and  the  amount  re- 
ceived. 


/ 


MO 


ACCOUNT    CLASSIFICATION 
Sinking  Fund 


Debit: 

1.  Cash  transferred   from  gen- 

eral funds  of  the  business 
to  a  special  fund  for  the 
specific  purpose  of  meeting 
some  fixed  obligation  at  a 
particular  time. 

2.  Income     derived     from     the 

sinking  fund,  crediting  at 
the  same  time  the  Reserve 
for  Sinking  Fund  account. 

3.  Balance    of    this    account 

should  represent  the  accu- 
mulated amount  of  the 
sinking  fund  which  is  an 
asset. 


Credit : 

1.  Amounts  of  money  disbursed 
for  the  purpose  for  which 
the  special  fund  was  set 
aside. 


Good-Will 


Debit: 

Credit  : 

I.    Actual  cost  of  good-will  ac- 

I. 

Amounts  written  off,  charg- 

quired upon  the  purchase 

ing  Surplus  account. 

of  a  going  business. 

2.    Balance    of    this    account 

should  remain  unchanged, 

unless  it  is  desired  to  write 

off   the   amount    of   good- 

will gradually  over  a  pe- 

riod of  years.    It  is  a  fixed 

asset  of  an  intangible  na- 

ture. 

ANALYSIS    OF    DEBIT    ACCOUNTS 
Returned  Sales 


411 


Debit: 

1.  Goods   returned   by   custom- 

ers, crediting  customers' 
accounts  therefor  at  same 
time.  Selling  price  is 
used. 

2.  Balance   of   this   account   to 

be  periodically  transferred 
to  Sales  account,  after 
which  this  account  is 
closed. 


Credit: 


Sales  Rebates  and  Allowances 


Debit: 

1 .  Total  amount  as  shown  in  re- 

bate journal. 

2.  Balance    to    be    periodically 

transferred  to  Sales  ac- 
count, after  which  this  ac- 
count is  closed. 


Credit: 


In-Freight 


Debit: 

Credit: 

1.    Freight  inward  on   all  mer- 

chandise     purchased     for 

trading      purposes.        In- 

freight  may  be  charged  di- 

rect to  Purchases  account. 

2.    Amount    of    balance    to    be 

periodically  transferred  to 

Purchases    account,    after 

which     this      account     is 

closed. 

412 


ACCOUNT    CLASSIFICATION 
Cash  Discounts  Allowed 


Debit: 


Total  amount  of  discount 
allowed  customers  and 
credited  to  them  from  the 
discount  column  on  the  re- 
ceipt side  of  the  cash  book. 

Amount  of  balance  should  be 
transferred  to  profit  and 
loss  when  books  are  closed. 


Credit; 


Depreciation  of  Buildings 


Debit: 

Credit: 

1.    Proportionate     periodical 

amount    of   estimated   de- 

preciation, crediting  at  the 

same  time  Reserve  for  De- 

preciation of  Buildings  ac- 

count. 

2.    Balance  of  this  account  to  be 

periodically  transferred  to 

profit  and  loss  account. 

Note  : — Depreciation  on  other  assets  is  handled  in  the  same  way. 


Bad  ] 

3ebts 

Debit: 

Credit : 

I.    Proportionate     periodical 

estimated  loss  on  bad  ac- 

counts. 

2.    Balance  of  this  account  to  be 

periodically  transferred  to 

Profit     and     Loss,     after 

which    this    account    i  s 

closed. 

ANALYSIS    OF    DEBIT    ACCOUNTS 
Interest  on  Bonds 


413 


Debit: 

1.  Interest  on  bonds  outstand- 

ing applicable  to  the  closed 
period  under  considera- 
tion, crediting  the  Accrued 
Interest  on  Bonds  account. 

2.  Balance  of  this  account  rep- 

resents a  fixed  charge 
against  income,  and  is  to 
be  periodically  transferred 
to  profit  and  loss,  after 
which  this  account  is 
closed. 


Credit: 


Interest  on  Mortgages  Payable 


Debit: 

1.  Interest   on   mortgages   pay- 

able outstanding  applic- 
able to  the  closed  period 
under  consideration,  cred- 
iting Accrued  Interest  on 
Mortgages  Payable  ac- 
count. 

2.  Balance  of  this  account  rep- 

resents a  fixed  charge 
against  income,  and  is  to 
be  periodically  transferred 
to  the  Profit  and  Loss  ac- 
count, the  present  account 
being  thereby  closed. 


Credit  i 


414  ACCOUNT    CLASSIFICATION 

Miscellaneous  Expenses  (One  account  for  each) 


Debit: 

1.  All    items    of    expense    not 

taken  up  thus  far. 

2.  Balance  of  each  account  to 

be  periodically  transferred 
to  Profit  and  Loss,  after 
which  each  of  these  ex- 
pense accounts  will  be 
closed. 


Credit: 

1.    All  deductions  from  expenses 
as  shown  contra. 


CHAPTER   XXXVII 
ANALYSIS  OF  CREDIT  ACCOUNTS 

1 .    Introductory 

The  credit  accounts  listed  on  the  trial  balance  given 
in  Chapter  XXXVI  are  analyzed  in  this  chapter. 
Should  it  be  desired  to  locate  a  certain  account  readily, 
the  trial  balance  should  first  be  examined  to  find  out 
whether  or  not  the  desired  account  is  discussed.  Atten- 
tion is  again  called  to  the  fact  that  each  account  should 
be  viewed  in  the  light  of  all  the  transactions  presented. 


2.     Detailed   Analyses 


Notes    Payable 


Debit: 

Credit: 

I.    Cash  paid  on  notes  when  re- 

I; 

Face  value  of  all  notes  when 

deemed    by    the    business 

issued  by  the  business. 

and  face  value  of  notes  re- 

2. 

Balance     of     this      account 

newed    or    otherwise    can- 

should represent  the  aggre- 

celed. 

gate    face   value   of    notes 
of  the   business    outstand- 
ing.     They     are     current 
liabilities. 

Accounts 

Payable 

Debit: 

Credit : 

1.    Total    amount    of    debits    to 

1.    Total    amount    of 

indebted- 

trade  creditors'  individual 

ness  incurred  by 

the  busi- 

accounts    from   cash   book. 

ness   with  trade 

creditors 

The  amount  represents  all 

on  open  account. 

415 


H6 


ACCOUNT    CLASSIFICATION 


Accounts  Payable  (Continued) 


moneys  paid  to  trade 
creditors  to  apply  on  open 
account  plus  total  cash  dis- 
counts allowed  by  them. 

2.  Returns     which    have    been 

debited  to  creditors'  indi- 
vidual accounts  either  from 
(a)  returned  purchases 
journal;  or  (b)  journal,  if 
n  o  returned  purchases 
journal  is  kept. 

3.  Adjustments   decreasing  the 

accounts  payable. 


2.  Adjustments    increasing   the 

accounts  payable. 

3.  Balance      of     this      account 

should  represent  the  total 
amount  owing  trade  credi- 
tors as  displayed  in  the 
accounts  on  the  creditors' 
ledger,  or  the  aggregate 
amount  of  unpaid  vouchers 
if  the  voucher  system  is  in 
use.  It  represents  a  cur- 
rent liability. 


Notes    Receivable    Discounted 


Debit: 

Credit : 

1.    Face    value    of    notes    pre- 

1. 

Face    value    of    notes    dis- 

viously   discounted    which 

counted,    debiting    at    the 

have  become  due  and  have 

same    time    the    Cash    ac- 

been paid,  crediting  at  the 

count    for   the    amount   of 

same  time  the   Notes   Re- 

cash received,  and  the  Dis- 

ceivable account. 

count  Lost  account  for  the 

2.    Cash  payments  of  face  value 

discount  taken  by  the  bank. 

of     notes     defaulted     by 

2. 

Balance      of     this      account 

makers. 

should  represent  notes  dis- 
counted for  which  the  com- 
pany is  contingently  liable. 
It  represents  a  contingent 
liability. 

Accrued   Taxes 


Debit: 

Credit: 

1.    Amount    of    tax    bills    when 

1.    Periodical     proportionate 

they  are  paid. 

amount  of  taxes   accrued, 

ANALYSIS    OF    CREDIT    ACCOUNTS  417 

Accrued  Taxes  (Continued) 


debiting  the  Taxes  ac- 
count, or  some  other  ex- 
pense account. 
2.  Balance  of  this  account 
should  represent  taxes  ac- 
crued but  not  due.  It  rep- 
resents a  liability. 


Accrued   Interest  on   Bonds 


Debit: 

1.  Amount  of  payments  of  in- 
terest on  bonds  outstand- 
ing. 


Credit: 

1.  Periodical      proportionate 

amount  of  interest  accrued 
on  outstanding  bonds  dur- 
ing the  closed  period  under 
consideration,  debiting  In- 
terest on  Bonds  account. 

2.  Balance      of      this      account 

should  represent  interest 
accrued  and  not  due.  It 
represents  a  liability. 


Accrued   Interest  on   Mortgages   Payable 


Debit: 

1.  Amount  of  payments  of  in- 
terest on  mortgages  out- 
standing. 


Credit: 

1.  Periodical  proportionate 
amount  of  interest  accrued 
on  outstanding  mortgages 
payable  during  the  closed 
period  under  considera- 
tion, debiting  Interest  on 
Mortgages  Payable. 

2  Balance  of  this  account 
should  represent  interest 
accrued  and  not  due.  It 
represents  a  liability. 


418 


ACCOUNT    CLASSIFICATION 


Capital  Stock  Subscribed 


Debit: 

I.  Amount  of  subscriptions  (par 
value)  that  have  been  fully 
paid  for  by  subscribers, 
crediting  Capital  Stock  ac- 
count at  the  same  time. 


Credit: 

1.  Amount  of  subscriptions  for 

capital  stock  sold  on  the 
instalment  plan,  debiting 
the  Subscriptions  to  Stock 
account  at  the  same  time. 

2.  Balance     of     this      account 

should  offset  the  amount 
of  subscriptions  uncol- 
lected. 


Bonds 


Debit : 

Credit  : 

1.    Par  value  of  bonds  retired. 

1. 

Par  value  of  bonds  issued  or 
assumed. 

2. 

Balance  of  this  account 
should  represent  par  value 
of  bonds  outstanding.  It 
represents  a  fixed  liability 
if  the  bonds  do  not  mature 
in  one  year. 

Mortgages  Payable 


Debit : 

1.  Payments  made  on  account 
of  the  principal  of  mort- 
gages issued  or  assumed. 


Credit : 

1.  Principal    of    mortgages    is- 

sued or  assumed. 

2.  Balance      of      this      account 

should  represent  the 
amount  due  on  the  princi- 
pal of  mortgages  issued  or 
assumed.  It  represents  a 
fixed  liability. 


ANALYSIS    OF    CREDIT    ACCOUNTS 
Bond  Premium 


419 


Debit: 

I.    Proportionate  amounts  writ- 


ten    off     periodically 
profit  and  loss. 


to 


Credit: 

1.  Amount  of  premium  received 

on  bonds  sold  above  par. 

2.  Balance     of     this      account 

should  represent  the 
amount  of  bond  premium 
not  yet  written  off.  It  rep- 
resents a  deferred  credit 
item. 


RE8ERVE    FOR    DEPRECIATION    OF    BUILDINGS 


Debit: 

1.    Cost  of  replacements. 


Credit: 

1.  Proportionate     periodical 

amount  of  estimated  de- 
preciation, debiting  at  the 
same  time  (a)  Deprecia- 
tion of  Buildings  account 
if  building  is  used  for 
business  purposes;  or  (b) 
Rental  Income  if  building 
is  rented  to  outsiders. 

2.  Balance      of     this      account 

should  represent  the 
amount  reserved  available 
for  such  replacements  and 
renewals  as  cannot  fairly 
be  considered  as  mainte- 
nance. 


Note:    All  reserves  for  depreciation  of  assets  are  handled  in 
the  manner  indicated  above.    Other  examples  will  not  be  given. 


420 


ACCOUNT    CLASSIFICATION 


Reserve   for  Bad   Debts 


Debit: 

1.  Balances  of  accounts  con- 
sidered to  be  uncollectible, 
crediting  at  the  same  time 
the  customers'  accounts 
for  the  amounts  charged 
off. 


Credit : 

1.  Proportionate     periodical 

amount  of  estimated  loss 
on  bad  accounts  during  the 
year.  This  amount  is  a 
percentage  of  the  sales  for 
the  period,  estimated  to  be 
sufficient  to  provide  for 
losses  on  the  accounts 
charged  during  the  period, 
debiting  at  the  same  time 
Bad  Debts  account. 

2.  Balance      of     this     account 

should  represent  the 
amount  reserved  available 
for  writing  off  bad  debts. 


Reserve  for  Sinking  Fund 


Debit: 

Credit : 

1.    Deductions  due  to  loss  or  re- 

1. 

Amount  appropriated  out  of 

turn  of  cash  deposited  in 

profits  at  periodic  intervals 

the  sinking  fund. 

to  offset  the  sinking  fund, 

2.    Amount  of  transfers  or  ap- 

debiting either  Surplus  or 

propriations  from  the  sink- 

Profit and  Loss. 

ing  fund. 

2. 

Amount  of  all  income  from 
the  sinking  fund,  as  inter- 
est or  dividends. 

3. 

Amount  of  profits  on  sales  of 
securities  belonging  to  the 
sinking  fund. 

4. 

Balance  represents  the  sur- 
plus invested  in  the  sink- 
ing fund. 

ANALYSIS    OF    CREDIT    ACCOUNTS  421 

Surplus 


Debit : 

1.  Amount     of     dividends     de- 

clared. 

2.  Amounts      periodically      re- 

served  for   Sinking   Fund 
Reserve  account. 

3.  Adjustments    reducing    sur- 

plus. 

4.  Loss  shown  by  the  Profit  and 

Loss  account. 


Credit: 

1.  Net  profit  as  shown  periodi- 

cally by  the  Profit  and 
Loss  account. 

2.  Adjustments       increasing 

surplus;  e.  g.,  profits  of 
former  fiscal  periods  not 
previously  credited;  assets 
acquired  through  donation, 
etc. 

3.  Balance     of      this      account 

should,  at  the  close  of  any 
fiscal  period,  represent  the 
undivided  profits.  They 
are  part  of  the  capital. 


Dividends 


Debit: 

1.  Amount  of  dividends  paid, 
whether  by  cash  or  by  an 
issue  of  stock  or  otherwise. 


Credit: 

1.  Amount  of  dividends  de- 
clared, debiting  Surplus 
account  at  the  same  time. 


Surplus  from  Treasury  Stock 


Debit: 

1.  Excess  of  cash  or  other  con- 

sideration paid  for  treas- 
ury stock  over  its  par 
value. 

2.  Excess  of  par  value  of  treas- 

ury stock  sold  or  other- 
wise disposed  of,  over  cash 
or  other  consideration  re- 
ceived for  it. 


Credit: 

1.  Excess  of  par  value  of  treas- 

ury stock  acquired  over 
amount  of  cash  or  other 
consideration  paid  for  it. 

2.  Excess  of  cash  or  other  con- 

sideration received  over 
par  value  of  treasury  stock 
sold. 


422 


ACCOUNT    CLASSIFICATION 


Note:    When  treasury  stock  has  been  completely  disposed  of, 
the  balance  of  this  account  should  be  closed  into  Surplus. 

Capital  Stock,  Common 


Debit: 

1.    Par   value    of    any    common 
shares  retired. 


Credit : 

1.    Par   value    of    any   common 
shares  issued. 


Capital  Stock,  Preferred 


Debit: 

1.    Par  value  of  any  preferred 
shares  retired. 


Credit: 

1.    Par  value  of  any  preferred 
shares  issued. 


Capital  Stock  with  No  Par  Value 


Debit: 

Credit : 

1.    Number  of  shares  retired,  at 

1. 

Number  of  shares  issued,  at 

price  at  which  they  were 

sale   price   thereof,   debit- 

credited   to    this    account 

ing  cash,  or  other  property 

when  issued. 

account,  or  subscriptions, 
as  case  may  be. 

2. 

Subsequent  sales,  at  sale 
price  thereof. 

Sales 


Debit: 

1.  Balance   of    Returned   Sales 

account. 

2.  Balance    of    Sales     Rebates 

and  Allowances  account. 


Credit : 

1.  Amount  of  total  charge  sales 

during  period. 

2.  Amount   of   total  cash   sales 

during  period. 

3.  Balance    to    be    periodically 

transferred  to  Profit  and 
Loss  account,  after  which 
this  account  will  be  closed. 


ANALYSIS    OF    CREDIT    ACCOUNTS  423 

Cash  Discounts  Received 


Debit: 


Credit: 

1.  Total    amount    of    discount 

allowed  us  by  creditors 
and  debited  to  them  from 
the  discount  column  on  the 
payment  side  of  the  cash 
book. 

2.  Amount  of  balance  should  be 

transferred  to  profit  and 
loss  when  books  are  closed, 
after  which  this  account 
will  be  closed. 


Interest 


Debit: 

1.  Amount  of  discount  on  notes 

discounted. 

2.  Amount  of  the  interest  paid 

on  notes  or  loans  at  the 
date  of  their  maturity,  or 
from  time  to  time,  as  the 
circumstances  may  require. 

3.  Periodical  proportion  of  the 

interest  paid  in  advance 
applicable  to  the  current 
fiscal  period  under  review. 


Credit: 

1.  Amount   of   interest   on   de- 

posits. 

2.  Amount  of  interest  on  notes 

receivable. 

3.  Amount  of  balance  should  be 

transferred  to  profit  and 
loss  when  books  are  closed, 
after  which  this  account 
will  be  closed. 


Note:    Separate  accounts  may  be  kept  for  interest  earned  and 
interest  expense. 


424? 


ACCOUNT    CLASSIFICATION 
Premium  on  Capital  Stock 


Debit. 


Credit : 

1.  Premium  on  sale  of  capital 

stock  above  par. 

2.  Balance     of     this      account 

should  be  credited  to  a 
special  surplus  account, 
after  which  this  account 
will  be  closed. 


Returned  Purchases 


Debit; 


Credit : 

1.  Goods    returned    by    us    to 

creditors,  debiting  credi- 
tors' accounts  therefor  at 
same  time. 

2.  Balance    to    be    periodically 

transferred  to  Purchases 
account,  after  which  this 
account  will  be  closed. 
Purchases  account  will 
then  reflect  the  net  pur- 
chases for  the  period. 


Purchase  Rebates  and  Allowances 


Debit: 

Credit: 

1.    Total   amount   as    shown   in 

rebate  journal. 

2.    Balance   to    be    periodically 

transferred    to    Purchases 

account,   after  which  this 

account  will  be  closed. 

ANALYSIS    OF    CREDIT    ACCOUNTS 
Miscellaneous    Income 


425 


Debit: 

1.    All  deductions  from  the  in- 
come shown  contra. 


Credit: 

1.  All  items  of  income  not  other- 

wise taken  up. 

2.  Balance    of    account    to    be 

transferred  to  Profit  and 
Loss,  after  which  this  ac- 
count will  be  closed. 


Profit  and  Loss 


Debit: 

Credit: 

1.    Balance  from  Purchases  ac- 

1.   Balance  from  Sales  account. 

count. 

2.    Credit  balances  from  all  in- 

2.   Debit  balances  from  all  ex- 

come accounts. 

pense  accounts. 

Note:    Balance  of  account,  debit  or  credit,  is  transferred  to 
Surplus  account. 


INDEX 


Acceptances,  trade  (See  "Trade  ac- 
ceptances") 
Account,      (See     also     "Accounts," 
"Accounting,"  "Ledger") 
Forms,  43 

books  of,  16 
original  entry,  39,  40 
secondary  entry  (See  "Ledger") 

debits  and  credits  defined,  17,  41, 
176 

deficiency,  140,  141 
Form,   140 

defined,  17 

form  of,  42-44 
Forms,  43 

mixed,  79-83 
adjusting,  80-83 
example  and  treatment  of,  80-83 

nominal,  59,  60 

personal,  58,  59  , 

profit  and  loss   (See  "Profit  and 
loss  account") 

real,  58,  59 
Accountancy, 

defined,  5,  16,  17 

functions  of,  classified,  5 
Accountant, 

defined,  16 

duties  of,   interlocking   bookkeep- 
er's duties,  6,  7,  16 

functions  of,  7-10,  13 
auditing,  9,  10 

clear  reports  and  statements,  9 
planning  and  adapting  systems, 
7 


recording    financial    history    of 
business,  8 

special  investigations,  9,  10 
professional,  13 
public,  certified,  13,  14 
training  of,  12 
Accounting,    (See    also    "Account," 

"Accounts,"  "Bookkeeping") 
advanced,  8,  9 
auditing,  9,  10 
cash  discount,  275-280 
constructive,  defined,  7 
corporation      (See     "Corporation 

accounting") 
cost,  11 

importance  of,  recognized,  11 
methods,  modernization  of,  3-5 
partnership   (See  "Partnership") 
presentation  of  figures  in   state- 
ments, 8,  153 
problems,  11,  12 

systems,  planning  and  installing,  7 
terms  used  in,  16-26 

account,  17 

accountancy,  16,  17 

accountant,  16 

assets,  20 

!>ookkeeper,   16 

books  of  account,  16,  2'J 

capital,  -'-' 

corporation,  19 

credit,  17 

debit,  17 

liabilities,  21 

partnership,  18 

proprietorship,  sole,  18 

statement,  25 


427 


428 


INDEX 


Accounts,  (See  also  "Account,"  "Ac- 
counting," "Ledger") 
adjusting,  79-83,  281 
analysis  of,  399-425 

credit  accounts,  415-425 

debit  accounts,  399-414 
asset,  65 

depreciation,   317-321 
balancing,  44 
capital,  67 
classification,  57-69,  259,  399-425 

aid  to  correct  bookkeeping,  62- 
64 

aid    to    preparation    of    state- 
ments, 64,  65 

correct,  importance  of,  57 

subdivisions,  60-62 
closing, 

entries,   83-86,   91,  92,   100,   101 

example  of,  84-86 

order  of,  100,  101 

provision  for  discounts,  281 
controlling    (See  "Controlling  ac- 
counts") 
credit,  analysis  of,  415-425 
debit,  analysis  of,  399-414 
expense,    68,    69,    236     (See    also 

"Expense  accounts") 
income,   67 

journal  entries    (See  "Journal") 
liability,  66 
offsetting  entries,  64 
opening,  entries,  180,  263,  339-343, 

367,  370 

Forms,  181,  339,  340,  367,  368 
payable,  113,  267 

analysis  of,  415,  416 
posting  to   (See  "Ledger,  posting 

to") 
receivable,  109,  266 

analysis  of,  402 

schedule  of,  157,  158 

uncollectible,  326,  327 
use  of,  illustrated,  41,  42 


Adjustments,  (See  also  "Entries,  ad- 
justing") 
capital  or  surplus,  schedule  of,  159 
Advertising,  charging  expense  of,  65, 

98,  113,  119 
Allowances, 

discount  (See  "Discounts") 
journal  entries,  184 
American  Institute  of  Accountants, 

14 
Analysis  of  accounts,  399-425 
credit  accounts,  415-425 
debit  accounts,  399-414 
Appreciation  of  land  values,  325 
Asset   and  liability  method,   single- 
entry  bookkeeping,  392,  393 
Assets, 

accounts,  65 

ascertaining,  method   of,  46 
book  value,  132,  133,  138 
current,  65 
deferred  expense,  65 
defined,    20,    21 

depreciation,  315    (See  also  "De- 
preciation") 
disposition  of, 
losses,  35 
payments,  35 
withdrawals,  35 
fixed,  62,  65 
sale  of,  112 
liquidation,  146-148 
recording,  illustrated,  62,  63 
sources  of,  34,  35 
creditors,  34,  35 
profits,  31,  34,  35 
proprietor,  34,  35 
tangible    and    intangible,    single- 
entry,  393,  394 

aluing    and    stating,    insolvency, 
132,  138 
Assets  .and  liabilities, 

statement     of,     46-49     (See     also 
"Balance  sheet,"  "Statement") 
Forms,  46,  47,  48,  49 


INDEX 


429 


Assignees  (See  "Receivers") 
Auditing,  9,  10 

necessity  for,  74 
Auditor,   functions  of,   10 

B 

Bad  debts  (See  "Debts,  bad") 
Balance, 
account,  44 
bank, 

interest  on,  111 

reconciliation  of,  225-227 
cash  book,  reconciliation  of,  225- 

227 
in  hand  and  on  deposit,  108 
Balance   sheet,   58,  59,   102,   116-128 

(See  also  "Statement") 
account  form,  117 

Forms,  118,  337 
assets  and  liabilities,  arrangement 

of,  117-119 
corrected,  126 

Form,  126 
date  of,  122 
deficit,  showing  of,  119 
defined,  116 

depreciation  reserve,  318 
inadequacy  of,  for  insolvents,  130, 

131 
incorrect  form  of,  121 

Form,  121,  122 
information  shown,  129 
items,  arrangement  of,  122,  123 
liabilities,  showing  of,   119,   120 
purpose  of,  116 

real  and  personal  accounts,  58,  59 
receiver's,  143,  149 

Form,  151 
representing    insolvency,   example 

of,  134,  135 

Form,  134,  135 
statement  form,  117 

Forms,  103,  118,  119 
Bank, 

RCCOOnt,  charge  for,  M 


balance, 
interest  on,  111,  220 
reconciliation    of,    225-227 
columns  in  cash  book,  228 
statement,  224,  225 

Form,  224 
transfers,  recording,  228,  229 
Bills  of  exchange,  295 
Bonds, 
account,  analysis  of,  418 
discount  account,  analysis  of,  407 
interest  on  (See  "Interest") 
owned,  account,  analysis  of,  404 
premium,  account,  analysis  of,  419 
schedule  of  investment,  159 
Bonus  on  total  purchases,  277 
Bookkeeper, 
defined,  16 

duties    of,    interlocking    account- 
ant's duties,  6,  7,  16 
Bookkeeping, 
double-entry,  38-45 
purposes  of,  79 
value  of,  175 
what  must  be  shown,  38 
when  should  be  used,  38 
kinds  of,  38 

records,  primary  purposes  of,  24 
single-entry,  38,  377-395 
cash  book,  382-384 

Form,  383 
day-book,     378-381      (See     also 
"Day-book") 
Form,  379 
fundamental   characteristic,  377 
inadequacy  of,  394 
ledger,  381,  382 

Form,  382 
ledger  accounts,  insufficiency  of, 

385 
profit    and    loss,    methods    and 
formulas  for  determining,  389- 
394     (Sec     also     "Profit     and 
loss") 


430 


INDEX 


Bookkeeping — Continued 
single-entry— Continued 
statement  of  condition,  385-389 
(See  also  "Statement  of  con- 
dition") 
Forms,  387,  388 
summary  of  changes  of  assets 
and  liabilities,  389 
Form,  389 
tangible   and   intangible   assets, 

393,  394 
when  may  be  used,  38 
Book  of  original  entry, 
defined,  39 

entering  business  transaction,  ex- 
ample, 40 
errors  occurring  in,  73,  74 
Books  and  records  (See  list  at  end 
of  Table  of  Contents  in  front  part 
of  book) 
Book  value,  132,  133,  138 
Buildings, 
account,  analysis  of,  409 
depreciation  (See  "Depreciation") 
Business, 
and    proprietor,    relationship    be- 
tween, 19,  20 
information,    recording,    22,    23 
insolvent   (See  "Insolvency") 
statement  of  a  going,  47-49 
transaction, 

analysis  of  a,  39 
changes  in,  recording,  49 
factors  involved  in,  39 
first  entry  of,  39 


Capital,  28-36 
account,  67 
closing    drawing    account    into, 

100,  101 
closing  profit  and  loss  into,  83- 
86 
accountant's  point  of  view  of,  30 


accounting  definitions  of,  22,  28 
additions  to,  35,  36,  112 
adjustments,  schedule  of,  159,  160 
ascertaining,  method  of,  46 
changes  in, 

adjustments  of,  159,  160 

causes  of,  35,  36 

examples  of,  36 

factors  of,  389 

summary  of,  34-36 
deductions  from,  35,  36 
economic  definition  of,  29,  30 
income  and  expense,  99 
incorrectly  defined,  33 
nature  of,  120 
net  worth,  29 
or  deficit,  determining,  46-52 

method   of,  46,  47 

subsequent  facts,  recording,  49- 
51 
partnership      (See     "Partnership, 

Capital") 
stock, 

accounts,  analyses  of,  422 

common,  366 

dividing  into  shares,  364,  365 

donated,  372,  373 

instalment  account,  analysis  of, 
405 

owned,     account,     analysis     of, 
404 

preferred,  366,  367 

premium,   account,   analysis  of, 
424 

subscribed,  account,  analysis  of, 
418 

subscriptions    account,    analysis 
of,  405 

subscriptions  paid  subsequently 
or  in  instalments,  369 
withdrawals  of   (See  "Withdraw- 
als") 
working,  124 
Card  ledger,  260 


INDEX 


481 


Cash, 
account, 

analysis  of,  401 

receiver's,  149 
Form,   150 
balance,  194,  195 

testing,  195 

verifying,  225-227 
book   (See  "Cash  book"  below) 
discounts  (See  "Discounts,  cash") 
petty,  191,  229 

account,  analysis  of,  401 

book,  231 

imprest  system,  229-231 
purchases,   113 

realization  and  liquidation  state- 
ment, 147 
receipts  and  payments,  statement 

of,    104-115     (See    also    "State- 
ment,   receipts   and   payments) 
receipts,  deposit  in  bank,  193 
sales,  110,  249-252 
Cash  book,  188-197,  215-217,  382-384 
arrangement  of  entries,  189,  190 
balance,  reconciliation  with  bank 

balance,  225-227 

entry  in  cash  book,  226,  227 
Form,  227 

method,  226 
bank  columns,  228 
closing,  195-197 
columnar,  215-217,  284,  328 

Forms,  216,  217,  288,  289,  330, 
881 
dates,  entering,  192 
discount  column,  215-217,  279,  280 

analysis  of,  217 
entries,  illustrative,  284-293 
footings,  192 
headings,  284,  285 
modern,  development  of,  215 
petty  cash,  231 
posting  to  ledger,  196,  291-293 
receipts   and   payments,    separate 

books  for,  190 


ruling  of,  284,  285 
simple,   191 
Form,  191 
single-entry   bookkeeping,  382-384 

Form,  383 
treated  as  ledger  account,  190 
Certified  public  accountants,  13,  14 
Charges,   deferred    (See   "Deferred, 

charges") 
Checks, 

cancelled,  241 

exchange  charges,  218,  219 

exchanged,  219,  220 

method    of   entry   on   books,    193, 

194 
proof  of  payment,  193 
void,  223 
voucher,  217 
Classification, 

accounts,  57-69,  259,  399-425  (See 
also    "Accounts,    classification," 
"Analysis  of  accounts") 
functions  of  accountancy,  5 
Closing  entries,  83-86,  91,  92 
proprietors'      drawing     accounts, 

100,  101 
provision  for  discounts,  281 
"C.  O.  D."  sales,  110,  254 
Compensating,  errors,  73 
Constructive  accounting,  7 
Containers,  sale  of,  253 
Contingent  liabilities    (See   "Liabil- 
ities, contingent") 
Controlling   accounts,   243-245,   259- 
270 

advantages  of,  260-262 
entries, 
current,   265 
unusual,  267 
function  of,  259 
ledger,  self-balancing,  243,  269 
opening,  262-264 

journal  entry,  M 
posting,  263,  264 

labor-saving  devices,  264 


±32 


INDEX 


Controlling    accounts — Continued 
principle,  extension  of,  270 
proving  balance,  244 
subsidiary  ledger,  posting  to,  265 
Corporation, 

accounting,  362-373 

features  of,  special,  362 
opening  entry,  involving  good- 
will, 370,  371 
Form,  371 
opening  entry,  simple,  367 

Form,  367,  368 
procedure,  367-371 
denned,  19,  362 
legal  requirements,  362-364 

capital,  withdrawals  of,  362,  363 
profit  and  loss,  364 
promoting  uncertain  business  ven- 
ture, 371-373 
protection  of  creditors,  legal,  362- 

364 
stock   certificate,  364,  365 
Cost, 

goods  sold,  96 
analysis  of,  161 
information  necessary,  161 
method  of  ascertaining,  201-204 
schedule  of,  161 
Cost  accounting,  11 
Creditors,  status   of,   in  liquidation 

proceedings,   146 
Credits  defined,  17,  41,  176 
Current, 
assets,  65 
liabilities,  66 


Day-book,  378-381 
Form,  379 
entries,  380 

transactions  included  in,  380 
posting  to  ledger,  methods  of,  381, 
382 
Form,  382 


requirements  for,  378 
ruling  and  form,  379 
Debits,  defined,  17,  41,  176 
Debts,  bad, 

account,  analysis  of,  412 
provision  for,  326,  327 
reserve  account,  analysis  of,  420 
Deferred, 

charges,  63,  65,  98,  113,  119 
income,  66 
Deficiency  account,  140,  141 
Deficit, 

ascertaining,  method  of,  46 
defined,  33,  34 

showing  of,  on  balance  sheet,  119 
Deposits, 

charged  back,  222 
interest  on,  220 
Depreciation,  315-327 

accounting  covering,  317-319 
account,  nominal,  318 
assets  subject  to,  315 
buildings, 

account,  analysis  of,  412 
reserve  account  analysis  of,  419 
causes  of,  315,  316 
obsolescence,  315,  316 
time,  lapse  of,  315 
wear  and  tear,  315 
defined,  315 
fluctuations,  326 
journal  entry,  318 
kinds  of,  316,  317 
physical  and  functional,  316,  317 
rates,  determination  of,  321-325 
fixed  -percentage-o  f-diminishing- 

value  method,  322-324 
sinking-fund  method,  324,  325 
straight-line  method,  322 
reserve  for,  138,  317-320 
separate  accounts,  318 
Discounts,   271-283 
bank,  299 
bond,  account,  analysis  of,  407 


INDEX 


488 


Discounts — Con  tinned 
cash,  99,   275 

abolishing,  desirability  of,  282 
account,  analysis  of,  412 
accounting  treatment  of,277-280 
bonus  instead  of,  282,  283 
calculating,  basis  for,  276 
cash  book  column  for,  279,  280 
cash  book  entry,  217 
disadvantages  of,  283 
journalizing,  277,  278 
nature  and  elements  of,  275 
not  deducted  in  calculating  bon- 
us on  total  purchases,  277 
provision  for,  in  closing  entry, 

281 
received,    account,    analysis   of, 

423 
recording  as  cash,  278,  279 
"terms,"  233 
columns  in  cash  book,  215-217 
defined,  271 
notes  receivable,  299 

accounting  covering,  300 
trade,  100,  271-275 

calculating,  quick  methods,  272- 

274 
stating,  methods  of,  272 
Dissolution,      partnership,      352-361 
(See    also    "Partnership,    dissolu- 
tion") 
Dividends, 

account,  analysis  of,  421 
stock  owned,  111 
Double-entry       bookkeeping       (See 

"Bookkeeping,  double-entry") 
Drafts, 

acceptance  of,  304,  305 

accounting  covering,  101 
collected  by  bank,  221 
Drawings    (See  "Withdrawals") 


Economics,  defined,  30 
Economist,  BO 


Efficiency,  increased  by  modern  ac- 
counting methods,  4 
Entries, 

adjusting,  79-83 
merchandise  accounts,  81 
mixed     account,     example     and 
treatment  of,  80-83 
closing,  G3-85,  91,  92 
example  of,  84-86 
proprietors'    drawing   accounts, 

100, 101 
provision  for  discounts,  281 
current,  265 
offsetting,   64 
opening,  180 
Form,  181 
controlling  accounts,  263 
corporation     accounting,     367, 
368,   370,   371 
Form,  367,  368 
partnership  accounting,  339-343 
Form,   339,   340 
original,   grouping   into   accounts, 

39 
unusual,  267 
Errors, 
compensating,  73 
locating,  73,  261,  262 
Exchange, 
bills  of,  295 
charges,  218 

methods  of  making,  218,  219 
Expense, 
accounts,  68,  69,  236 

"catch-all,"      inadvisability     of, 

162 
posting  to   profit   and  loss   ac- 
count, 52 
purchase  journal,  BM 
selling  expenses,  97,  98 
administrative,  69 
and    expenditure,    distinction    be- 
tween, 107 
<  l.issific.ition  essential,  99,  162 


434 


INDEX 


Expense — Continued 

deferred,  65,  98,   113,   119 

explanation  of  items  advisable, 

99 
schedule  of,  162 

miscellaneous,    accounts,    analysis 
of,   414 

organization,  account,  analysis  of, 
406 

prepaid      (See     "Expense,     de- 
ferred") 

recording,  63 

selling,  68,  97,  98 


Fiscal  periods,  232,  233 

Fixed  assets   (See  "Assets,  fixed") 

Fixed-percentage  method  of  depre- 
ciation rates,  322-324 

Freight, 
charging  to  accounts,  97 
deducted  from  sales,  when,  96 
inward,  analysis  of  account,  411 
outward,  253 

Furniture     and     fixtures     account, 
analysis  />f,  409 


General     journal      (See     "Journal, 
general") 

Good-will,  370 

account,   analysis  of,  410 
corporation  accounting,  369,  370 


Imprest    fund,    229-231 
Income, 
accounts,  67 

posting  to   profit   and   loss   ac- 
count, 52 
deferred,  66 
dividends  on  stocks,  111 


interest  on — 
bonds,  110,  111 
investments,  100 

miscellaneous,     account,     analysis 
of,  425 

sales,  67,  110 
Income     and     expense      (See     also 
"Profit  and  loss") 

capital,  99 
Insolvency     (See    also    "Realization 
and       liquidation       statement," 
"Statement  of  affairs") 

balance  sheet  inadequate,  130,  131 

defined,  130 
Insurance  prepaid,  65,  98,   114,  119 

account,  analysis  of,  407 
Interest, 

account,  analysis  of,  423 

bank,  111,  220 

bonds, 
account,  analysis  of,  413 
accrued  interest  account,  analy- 
sis of,  417 
owned,  110,  111 

deducted,  cash  book  entry,  217 

investments,   100 

mortgages  payable, 

account,  analysis  of,  413 
accrued  interest  account,  analy- 
sis of,  417 

notes  receivable,  299 

partnership,   adjustment  of  capi- 
tal, 348-350 

prepaid,  account,  analysis  of,  407 
Inventory, 

analysis  of,  403 

estimating,  204,  205 

perpetual,   201 

schedule,  158 

purposes  and  uses  of,  158,  159 

valuation,   123 
Investigations,  special,  9,  10 
Investments, 

interest  on,  100 

schedule  of,  159 


INDEX 


435 


Journal, 

cash  (See  "Cash  book") 

columnar,   306-309 
Form,  309 

development  of,  306 

entries, 

Forms,   171,   172,  185,   186 
closing,  monthly,  313 
date  and  amounts,  174 
equilibrium    of,    175,    176 
explanations  covering,  173 
form  of,  170-172 
illustrative,  307,  310-313 
items,  adding  the,  174 
kinds  of,  306 
object  of,  172 
opening,  180 
Form,   181 
opening  controlling  account,  263 
partnership    (See  "Partnership, 

accounting") 
purchases  and  sales,  182,  183 
receipts  and  payments,  183,  18 1 
returns  and  allowances,  184 
rules  for,  175,  176 
use  of  "to"  and  "by,"  173,  174 

form  of,  170-172 

function  of,  170 

general,   177 
Form,  332 
development  of,  176,  177 
cut rits  included  in,  177 

ledger   in   relation   to,  170 

posting  to  ledger,  175,  263,  2<>l 

problems,    illustrative,    179-187 

purchase,  198-200,  232-239 
Forms,  200,  333 
analysis  of  entries,  231 
closing,  236,  237 
departmental,  simple,  981 

Form,  234,  235 
expense  accounts,  188 
folio  column,  2'M> 


form  of,  198 
function  of,  198 
returns,  238 
summary,  237,  238 
use  of,   illustrated,   198-200 
voucher  register,  241 
sales,  207,  208,  248 

Forms,  208,  332 
analytical   form  of,  248 

Form,  250,  251 
cash  sales,  249-252 
charge  entries,  249 
C.  O.  D.  sales,  254 
containers,  253 
entries   by  number,  249 
form  of,  207,  208 
freight  outward,  253 
function  of,  207 
proprietor,  sales  to,  252,  253 
returned  sales,  254 
special  forms  and  methods,  255 
sundry  sales,  249-252 
terms  of  sale,  248 
subsidiary,  188 

advantages  of,  188,  189 
columnar,  use  of,  328-337 

Forms,  330,  331,  332,  &33 
Journalizing,  rules  for,  175,  176,  399 


Land, 

account,  analysis  of,  408 
appreciation  of,  326 
Ledger,   (See  also  "Account,"  "Ac- 
counts") 
accounts,  42-45 
Forms,  43 
analysis  of,  399-425 
arrangement  of,  259 
balancing,  44 

classification,    57-69,    259,    399- 
425      (See     also      "Accounts, 
classification") 
forms  of,  M  li 


INDEX 


Ledger — Continued 
accounts — Continued 

payable,  267 

receivable,  266 

single-entry,  insufficiency  of,  385 

trial    balance,    71-77    (See    also 
"Trial  balance") 
card,  260 

controlling  account,  243-245,  250- 
270 

proof  of  balance,  244 
creditors,  inadequacy  of,  240 
functions  of,  50 
journal    in    relation    to,    function 

of,  170 
loose-leaf,  260 
posting  to,  175 

cross-indexing,  175 

errors  in,  detecting,  74 

labor-saving  devices,  264 

methods  of,   196,  237,  263,  264, 
291-293,  381 

time  of,  267 
purchases,  recording,  200 
recording    accounts    direct    inad- 
visable, 167-170 

example,  167-169 

reasons  why,  169,  170 
record,  insufficiency  of,  167 

illustrative    problem,    167-169 
self-balancing,  243,  269 
single-entry  bookkeeping,  381-382 

Form,  382 
subsidiary,  259 

controlling  account  in,  269 

posting  to,  265,  267 

self-balancing,  269 
transactions,  illustrative,  41 
trial  balance,  268 
Liabilities, 
accounts,  66 

ascertaining,  method  of,  46 
contingent,  120 

notes,      discounted     or     trans- 
ferred, 300,  301 


notes      receivable,      discounted, 
120,  157 
current,  66 
denned,  21 
fixed,  66 
secured,  133 
showing  of,  on  balance  sheet,  119, 

120 
statement  of,  insolvency,  133 
Liquidation,    (See  also   "Realization 
and       liquidation       statement," 
"Statement  of  affairs") 
partnership,     352-361      (See     also 

"Partnership") 
receivership,  142 
status  of  creditors  in,  146 
Liquidation    and    realization    state- 
ment, 142-152   (See  also  "Realiza- 
tion and  liquidation  statement") 
Form,  145 
Liquidators  (See  "Receivers") 
Loose-leaf  ledger,  260 
Loss, 

defined,  32 

recording  items  showing,  50-52 
Losses,    partnership,    sharing,    358, 
359 

M 

Merchandise, 

account,  adjusting,  81 

gross  profit  on,  ascertaining,  81 

sales  to  proprietor,  209 

sold,  determining  cost  of,  96,  97 
Mixed  accounts,  79-83 

adjusting,  80-83 
Modernization  of  accounting  meth- 
ods,  3-5 

purposes  of,  4 
Mortgage, 

interest      (See     "Interest,     mort- 
gage") 

payable,  account,  analysis  of,  418 

real  estate,  124,  125 


INDEX 


VV, 


Mortgage — Continued 

receivable,    account,    analysis    of, 

404 
schedule  of  investment,  159 
treatment    of,    statement    of    af- 
fairs, 138 


N 


Net  worth   (See  "Capital") 
Nominal  accounts,  59 
Notes,   294-304 

collected  by  bank,  221 
discounted,  299,  300 

contingent    liability,     120,     157, 

300,  301 
dishonored,  302 

payment  of,  journal  entry,  301, 
302 
dishonored,  296,  302 

accounting  covering,  298 
interest,  297,  298 
paid  for  depositor,  222 
payable,  294,  304 

account,  analysis  of,  415 
schedule  of,  157 
treatment  of,   statement  of  af- 
fairs,   139 
promissory,  denned,  294 
protest  of,  221,  298 
charging   fees,  221 
receivable,  294 

account,  analysis  of,  402,  403 
accounting  covering,  IM 
collected,    accounting    covering, 

297 
discounted,      account,      analysis 

of,  416 
schedule  of,  157 
register,  297,  303 


Obsolescence,  315,  316 
Offsetting  entries,  <>t 


Opening     entries      (See     "Entries, 

opening") 
Original  entry, 

books  of  (See  "Books  of  original 
entry") 

grouping,  39,  40 

illustrated,  41 
Overpayments, 

avoiding,   in   partnership   dissolu- 
tion, 356-358 

refunds  for,   112 


Partnership, 
accounting,  338-361 

capital    indefinite,    opening   en- 
try, 341,  342 

features  of,  special,  338 

no  capital  contributed,  opening 
entry,  342 

opening  entry,  usual,  339-3 11 
Form,  339,  340 
capital, 

accounts  separate,  338 

adjustments,  348-350 

assets  other  than  cash,  33!» 
denned,  18 
dissolution,  352-361 

accounting  covering,  354 

causes  of,  352,  353 

debit    balance   against    partner. 
358,  359 

distribution   of   assets,   353 

distribution   of  proceeds,  356 

distribution  Of  proceeds,  instal- 
ment method,  356 

illustrative  problem,  355 

losses,  sharing,  357-359 

methods  of,  MS 

overpayment  of  partners,  avoid- 
ing, BM-M 

procedure,  Ml 

sale  of  business,  359-:i<;i 


INDEX 


Partnership — Continued 
interest, 

accounting  covering,  349,  350 
capital  adjustment,  348-350 
profits  and  losses,  division  of,  343 
bases  of,  344 
capital  and  time,  basis  of,  345- 

347 
capital  invested,  basis  of,  344 
fixed  percentages,  344 
salaries,  348,  350,  351 

considered  as  expense,  351 
partnership    agreement,   350 
sale  of  business,  359-361 
withdrawals,  349 
Payments,  107 
cash, 

arrangement  of  items,  order  of, 

109 
statement  of,  104-115 
disbursements,    distinction    be- 
tween, 107 
identification  of,  193,  194 
journal  entry  of,  183,  184 
method  of  making,  193,  194 
proof  of,  193 
Petty  cash  (See  "Cash,  petty") 
Posting   (See  "Ledger,  posting  to") 
Prepayments,  65,  98,  113,  119 
Profit, 
defined,  31,  32 
gross,  96,  110,  200,  201 
determining,  85 

on  merchandise,  ascertaining,  81 
net,  determining,  85,  86 
recording  items  affecting,  50-52 
Profit  and  loss, 
account, 

Form,  86 
adjusting  entries,  85 
analysis  of,  425 
closing  entries,  83-85,  91,  92 
nominal,  59 

subsequent  facts,  recording,  49- 
51 


time  of  opening,  84 
trial  balance,  89-91 

Form,  90 
use  of,  52 
determination  of,  79-87 
double-entry,   79 
proving  correctness  of,  87 
single-entry  bookkeeping, 

asset  and  liability  method,  392, 

393 
formulas   for   determining,  390- 

392 
inadequacy   of,   394 
method     of     determining,     389, 

390 
summary   of   changes   of  assets 
and  liabilities,  389 
Form   389 
tangible    and    intangible    assets, 
393,    394 
statement,  89-103 
Form,    336,    337 
accounting  procedure,  95-102 
and     account,     distinction     be- 
tween, 95 
function  of,  89 
corrected,  101,  102 

Form,   101,   102 
form  of,  94,  95 
incorrect,  92 

Form,  92,  93 
title  of,  93,  94 
Profit-sharing,   partnership,  343-347 
Proprietor, 

and     business,     relation     between, 

19,  20 
drawings  by,   114 
information  necessary  to,  24 
sales  to,  209,  252,  253 
Proprietorship,  sole,  18 
Protesting  notes,  221,  298 
Purchase     journal     (See     "Journal, 

purchase") 
Purchase    rebates    and    allowances, 
analysis  of,  424 


INDEX 


439 


Purchases, 

account,  200 

analysis  of,  403 

closing,  202,  203 
Forms,  202,  203 

operating  of,  202 
cash,   113 

discount  on,  not  deducted,  97 
returned,      (See     also     "Returns, 

purchases") 

account,  analysis  of,  424 


Rates,    depreciation     (See    "Depre- 
ciation, rates") 
Real  and  personal  accounts,  58,  59 
Real  estate  mortgage,    124*   125 
Realization    and    liquidation    state- 
ment, 142-152 

Form,   1 15 
assets, 

realized,   147,   148 
to  he  realized,  146 
cash  included  among  assets,  117 
credits,  supplementary,  148 
dehits,  supplementary,  149 
form  of,  143 

information  required,   143,   111 
liabilities, 

liquidated,   148 
to  he  liquidated,  147 
unliquidated,  149 
preparatory  .statements,  148 
Rebates   (See  "Discounts") 
Receipts, 
cash, 

arrangement  of  items,  order  of, 

109 
statement  of,  104-115 
journal  entries  of,  183 
Receiver, 
appointment  of,   ir_* 

balance   sheet,    1 13,    149 
Form,    151 


cash  account,  140 

Form,  150 
deficiency  account,  140,  1 1 1 

Form,  140 
duties  of,   142 

realization   and   liquidation   state- 
ment, 142-152  (See  also  "Reali- 
zation   and   liquidation   state- 
ment") 
Form,  145 
reports,  143,  149 

statements,  143   (See  also  "State- 
ment of  affairs") 
Recording  business  information,  22, 

23 
Records,   (See  list  at  end  of  Table 
of   Contents    in    front    part    of 
book) 
primary  purposes  of,  24 
Refunds  by  creditors,  112 
Register, 
note,  297,  303 
voucher,  241 
Rent,  prepaid,  treatment  of,  98,  113 
Replacements,   accounting  covering, 

319-321 
Returns, 

purchases,  184,  238 

method  of  handling  entries,  888 
sales,    210    (See    also    "Sales,    re- 
turned") 


Salaries,  partners',  848,  350,  351 

Sale  of  partnership  basfaiessi  188 

361 
Sales, 

account,  208 

analysis  of,  189 
allowances,  99 
analysis  of,   160 
cash,  110.  HI 

accounting    procedure.    M 
charge,  249 


440 


INDEX 


Sales— Continued 
C.  O.  D.,  110,  254 
containers,  253 
deductions  from,  95-97 
discounts,  99 
fixed  asset,  112 

journal    (See  "Journal,  sales") 
rebates,  99 
rebates   and    allowances    account, 

analysis  of,  411 
recording,  by  tabulating  machine, 

160 
returned,  210 

account,  analysis  of,  411 

entering  in  journal,  254 
schedule  of,  160 
sundry,  249-252 
to  proprietor,  209,  252,  253 
Sales  book    (See  "Journal,  sales") 
Schedule, 

accounts   receivable,   157,   158 
capital    or    surplus    adjustments, 

159,  160 
cost  of  goods  sold,  161 

information  necessary,  161 
expenses,  general,  162 
inventory,  158 

purposes  and  uses  of,  158,  159 
investments,  159 
miscellaneous,  162 
notes, 

payable,  157 

receivable,    157 
sales,  160 
supporting,  153-163 

desirable,  when,  163 

example  of,  155,  156 

presentation,         Interpretative, 
principles     and     method     of, 
153-155,   163 
Scrap    value,    accounting    covering, 

319,  320 
Securities   owned   account,   analysis 

of,  404 
Selling  expenses,  97,  98 


Single-entry     bookkeeping      (See 

"Bookkeeping,  single-entry") 
Sinking  fund, 

account,  analysis  of,  410 
reserve  account,  analysis  of,  420 
Sinking-fund    method    of    deprecia- 
tion rates,  324,  325 
Sole  proprietorship,  18 
Statement,      (See      also      "Balance 
sheet") 
assets  and  liabilities,  46-49 
Forms,  46,  47,  48,  49 
summary  of  changes  of,  389 
Form,  389 
balancing,   49 
bank,  form  of,  224,  225 

Form,  224 
cash   discount,  treatment  of,  280, 

281 
contents  of,  25 
denned,  25 

form  and  arrangement  of,  26 
income    and    expenditure,    incor- 
rect,   92-94 
Form,  92,  93 
income    and    profit    and    loss,    94 
(See  also  "Profit  and  loss  state- 
ment") 

Form,   101,   102 
of  affairs,  129-141 
Form,  136,   137 
assets,  valuing  and  stating,  132 
deficiency   account,    supplemen- 
tary, 140,  141 
Form,  140 
example  of,  136-140 
form  of,  141 

information  required,  135,  136 
liabilities,  stating,  133 
treatment  of,  138-140 
of  condition,  385-387 
Form,  387 
comparative,  387-389 

Form,  388 
form  of,  386 


INDEX 


441 


Sta  tement — Continued 
of  going  business,  47-49 

Form,  48,  49 
]) reparation  of,  335 
classification  of  accounts  aid  to, 
64 
presentation,  interpretive,  8,  153 
method  of,  155 
principles  of,  154,  163 
profit  and  loss    (See  "Profit  and 

loss  statement") 
purpose  and  use  of,  25,  154 
realization    and    liquidation,    142- 
152   (See  also  "Realization  and 
liquidation  statement") 
Form,  145 
receipts  and  payments,  cash,  104- 
115 

Form,  106 
dates  of,  107 
details  included,  108 
form  and  content  of,  105 
items,  arrangement  of,  109 
items  not  disclosed,  114 
profit  and  loss  not  disclosed  by, 

104,  115 
purpose  and  use  of,  104,  115 
title  of,  106,  107 
Stock, 

capital    (See  "Capital  stock") 
dividends  on,  111 
schedule  of  investment,  159 
Straight-line  method  of  depreciation 

rates,  322 
Subsidiary  records,  use  of,  328-337 
(See  also  "Journal,  subsidiary") 
Forms,  330,  331,  332,  333 
Supplies, 

not     exhausted     (See     "Deferred 

charges") 
office,  account,  analysis  of,  408 
Surplus, 

account,  analysis  of,  421 
adjustments,  schedule  of,  159,  1C0 


Taxes,  accrued, 

account,  analysis  of,  416,  417 
Trade, 

acceptances,  304,  305 
discounts  (See  "Discounts,  trade") 
Trading  account,  203,  204 

Form,  204 
Transfers,  bank,  228,  229 
Treasury  stock,  371-373 
account,  analysis  of,  406 
surplus  account,  analysis  of,  421 
Trial  balance,  71-77,  127 
Form,   336 
errors,  locating,  73 

controlling  accounts,  261 
limitations  of,  73 
method  of  showing  balances,  72, 

73 
monthly,  268 
post-closing,  127,  128 
Form,  90 
analysis  of,  400 
preparation,  methods  of,  71 
illustrative  problem,  74-77 
preparation  of  balance  sheet  not 

obviated  by,  127,  128 
purpose  and  use  of,  71,  72,  73 
repetitions,  avoiding,  72 
Trustees   (See  "Receivers") 
Turnover,  210,  211 
calculating,  211 


Valuation, 

assets,  132,  138 

inventory,   123 
Voucher, 

canceled  checks,  241 

checks,  217 

folder,  Ml 
Form,  242 


442 


INDEX 


Voucher — Continued 
journal  entry,  canceling,  24G 
payment  of,  245-247 

allowances    and    discounts,    245 
record, 

Form,  244,  245 

operation  of,  241 

posting  from,  243 

purchase  journal  as,  240,  241 

system,  240-247 


W 
Wages,  113 
Withdrawals,  33 

accounting  covering,  209 

by  proprietor,  114 

closing  accounts,   100,  101 

directly,  33 

indirectly,  33 

partnership,  348,  349 
Working  capital,  124 


